Investment funds in Australia: regulatory overview

A Q&A guide to investment funds law in Australia.

This Q&A is part of the global guide to investment funds. It provides a high level overview of investment funds in Australia, looking at both retail funds and hedge funds. Areas covered include a market overview, legislation and regulation, marketing, managers and operators, restrictions and requirements, tax and upcoming reform.

To compare answers across multiple jurisdictions, visit the Investment Funds Country Q&A tool. For a full list of jurisdictional Q&As visit www.practicallaw.com/investmentfunds-guide.

Contents

Retail funds

1. What is the structure of the retail funds market? What have been the main trends over the last year?

Open-ended and closed-ended retail funds (described as funds, managed funds 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 Australian Corporations Act 2001 (Cth) (Corporations Act). Open-ended and closed-ended retail funds typically have to be registered with the Australian corporate regulator, the Australian Securities and Investments Commission (ASIC) (see Question 2, Open-ended retail funds: Regulatory framework).

Open-ended retail funds

The majority of retail funds in Australia are established as open-ended funds. There is no regulatory distinction between open-ended and closed-ended funds.

The Australian retail funds market is mature, with a high degree of regulation. The retail funds market is growing and is currently the fourth largest pool of funds under management in the world. As at September 2015, the managed funds industry had A$2.6 trillion in funds under management, an increase of A$151.2 billion (6%) on the September quarter 2014 figure (source: Australian Bureau of Statistics).

Over the past year, there has been a continuing trend towards regulatory reform, including:

  • There is continuing development towards introducing an Asia Region Funds Passport.

  • Treasury has been working on developing a suite of new, globally-recognised collective investment vehicles (CIVs).

  • On 20 October 2015, the Government released its response to the Final Report of the Financial System Inquiry, in which the Government accepted 43 out of the 44 recommendations made in the Final Report relating to the regulatory framework for the Australian financial services industry, including the retail funds market.

For more information on these reforms, see Question 15.

Closed-ended retail funds

A minority of retail funds in Australia are established as closed-ended funds. These funds usually share the same structure as open-ended funds (see above, Open-ended retail funds).

Closed-ended funds are typically:

  • Associated with particular illiquid asset classes, such as infrastructure and direct real property.

  • Offered to meet the needs of investors with long-term investment horizons.

Regulatory framework and bodies

2. What are the key statutes, regulations and rules that govern retail funds? Which regulatory bodies regulate retail funds?

Open-ended retail funds

Regulatory framework. Open-ended retail funds are primarily governed by the Corporations Act. Under the Corporations Act, retail funds are defined as "managed investment schemes" and are typically structured as unit trusts. Managed investment schemes are also known as funds, managed funds or schemes.

In addition to the Corporations Act, operators of retail funds are subject to the following legislation:

  • Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (AML/CTF Act).

  • Electronic Transactions Act 1999 (Cth).

  • Income Tax Assessment Act 1997 (Cth) (ITAA 1997).

  • Income Tax Assessment Act 1936 (Cth) (ITAA 1936).

  • A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act).

  • Taxation Administration Act 1953 (Cth).

  • Privacy Act 1988 (Cth).

If a retail fund is structured as a unit trust, general trust law (including fiduciary duties) will also apply to the operation of the trust.

If a retail fund is listed on a financial market, the operator of the retail fund must comply with the rules of the relevant market, which is usually the Australian Securities Exchange (ASX), and the rules for entities listed on the ASX are the ASX Listing Rules.

In addition, trading in interests in a retail fund must be conducted in accordance with the operating rules and market integrity rules of the relevant financial market (for example, the ASX Operating Rules and the ASIC/ASX Market Integrity Rules).

Regulatory bodies. The Australian Securities and Investments Commission (ASIC) is the primary regulatory body responsible for regulating managed investment schemes. ASIC is constituted under and acts in accordance with the:

  • ASIC Act 2001 (Cth).

  • ASIC Regulations 2001 (Cth).

ASIC is empowered under the Corporations Act to modify certain aspects of the Corporations Act applicable to retail funds by issuing instruments that either:

  • Apply to industry participants generally (class order relief).

  • Apply to specific entities (individual relief).

In addition to modifying the Corporations Act, ASIC provides guidance on how it administers its regulatory duties through the release of publications referred to as regulatory guides as well as other reports. These are available on ASIC's website (http://asic.gov.au/asic/asic.nsf). Prior to implementing any changes, ASIC generally engages with industry participants for their input through the release of consultation papers and inviting submissions on its proposals.

Other regulatory and supervisory bodies relevant to retail funds include the:

  • ASX, in the case of listed funds. This is the largest market operator for listed retail funds.

  • Australian Tax Office (ATO).

  • Australian Transaction Reports and Analysis Centre (AUSTRAC).

Closed-ended retail funds

Closed-ended retail funds are regulated in the same manner as open-ended retail funds and the same regulatory bodies apply to closed-ended retail funds (see above, Open-ended retail funds).

 
3. Do retail funds themselves have to be authorised or licensed?

Open-ended retail funds

In general, where an open-ended fund is offered to "retail clients" (as defined by the Corporations Act) it must be registered with the Australian Securities and Investments Commission (ASIC) as a managed investment scheme, as required by the Corporations Act. The Corporations Act includes a small number of exemptions from the need to register a retail fund with ASIC.

In addition, the operator of a retail fund must usually be licensed. For information regarding the licensing of fund managers (see Question 6, Open-ended retail funds: AFS licence).

In addition, the operator of a retail fund should:

  • Obtain a tax file number for the fund and appoint a public officer to be responsible for meeting the fund's tax reporting obligations.

  • Register the fund under the GST Act, if the GST turnover of the fund is A$75,000 or more. GST is Australia's equivalent of value added tax (VAT) and is currently payable at a rate of 10%.

Closed-ended retail funds

Closed-ended retail funds are subject to the same registration requirements as open-ended retail funds (see above, Open-ended retail funds).

Marketing

4. Who can market retail funds?

Open-ended retail funds

The marketing of retail funds will normally constitute providing "financial product advice" and so will be a "financial service" for the purposes of the Corporations Act.

If marketing a retail fund is taken to be "financial product advice", then generally, the entity marketing the fund (which may be the fund operator or someone else) must:

  • Hold an AFS licence with an authorisation to provide financial product advice (see Question 6, Open-ended retail funds: AFS licence).

  • Be authorised by the holder of an AFS licence to provide final product advice on behalf of the licensee as their appointed authorised representative.

  • As an alternative to holding an AFS licence, be able to rely on an appropriate licensing exemption.

Exemptions from holding an AFS licence may apply to persons providing financial services in Australia. For example:

  • Issuers of financial products can market their own products, subject to certain conditions (such as making prescribed disclosures).

  • Certain foreign financial services providers who are regulated in jurisdictions that ASIC considers to have a regulatory framework sufficiently similar to the Australian regime (such as the UK, US, Singapore, Hong Kong and Germany) may be eligible to apply for relief from licensing to enable them to market funds to Australian "wholesale" clients.

Closed-ended retail funds

Closed-ended retail funds can be marketed in the same manner as open-ended retail funds (see above, Open-ended retail funds).

 
5. To whom can retail funds be marketed?

Open-ended retail funds

There are no general legislative restrictions on the persons or entities that a retail fund can be marketed to in Australia (as distinct from institutional or wholesale funds that must be solely marketed to "wholesale clients", as defined under the Corporations Act). When retail clients are offered interests in a fund, in most circumstances those clients must be given a regulated disclosure document, called a product disclosure statement (PDS), which must comply with the content and format requirements under the Corporations Act, Corporations Regulations and the Australian Securities and Investments Commission (ASIC) policy and regulatory guidance (see Question 6, Open-ended retail funds: Disclosure).

Closed-ended retail funds

Closed-ended retail funds are marketed in the same manner (and are subject to the same disclosure requirements) as open-ended retail funds (see above, Open-ended retail funds).

Managers and operators

6. What are the key requirements that apply to managers or operators of retail funds?

Open-ended retail funds

The operator of a retail fund that is a registered managed investment scheme is referred to as the "responsible entity". The responsible entity of a retail fund must:

  • Be an Australian public company.

  • Hold an AFS licence authorising it to provide various financial services relevant to the operation of the fund, including a specific authorisation to operate a registered managed investment scheme (see below, AFS licence).

  • Either have a majority of directors who are external directors or have a compliance committee (to oversee the retail fund's compliance requirements) with a majority of "external members".

Although a responsible entity is responsible for operating a retail fund, it is open to a responsible entity to outsource the day-to-day management of a retail fund's assets to a third party investment manager.

Furthermore, an investment manager (including overseas managers) who does not satisfy the requirements for being a responsible entity (for example because of its corporate structure or because it does not hold the necessary AFS licence authorisations) can enter into an arrangement where an external or "outsourced" responsible entity is engaged. An outsourced responsible entity will operate a retail fund according to an investment strategy determined by the investment manager. From a strictly legal perspective, however, it is the responsible entity of a retail fund that engages the investment manager and is responsible for the acts of the investment manager.

Offshore investment managers who wish to establish an Australian retail fund to operate as a feeder fund for an offshore fund often engage an outsourced responsible entity. However, offshore investment managers will always need to consider whether their investment management activities will be caught by the AFS licensing requirements in the Corporations Act.

A registered managed investment scheme must be operated in accordance with all of the following:

  • The fund's trust deed (called a "constitution") and a "compliance plan".

  • The Corporations Act and the general law (for example, in accordance with both common law and equity) as it applies to both the responsible entity and the retail fund itself.

  • The responsible entity's and (where applicable) investment manager's AFS licence.

Further details of the requirements for operators of retail funds are set out below.

Constitution and compliance plan. The fund's constitution establishes the fund, specifies the powers of the responsible entity as the fund's operator and sets out (in general terms) how the fund is to operate. Key content requirements are prescribed by the Corporations Act, including provisions relating to:

  • The method to calculate the consideration to be paid (by an investor) to acquire an interest in the fund.

  • The powers of the responsible entity.

  • Dispute resolution procedures (for investors).

  • Circumstances and procedures that apply to winding up the fund.

The fund's compliance plan sets out the measures the responsible entity must take to ensure the fund's compliance with the Corporations Act and its constitution. The Corporations Act requires a fund's compliance plan to set out arrangements for:

  • Identifying and holding fund property.

  • Establishing a compliance committee (if required).

  • Valuation of the fund's property.

Corporations Act and the general law. The Corporations Act sets out obligations both for responsible entities and the officers/employees of responsible entities. These obligations broadly replicate obligations that are imposed on trustees under the general law, including requirements for a responsible entity to:

  • Act honestly and exercise the degree of care and diligence that a reasonable person would exercise if they were in the responsible entity's position.

  • Act in the best interests of the members (that is, the investors) and, if there is a conflict between the members' interests and its own interests, give priority to the members' interests.

  • Treat the members who hold the same class of interests equally and members who hold interests of different classes fairly.

  • Ensure that fund property is clearly identified as fund property and is held separately from the responsible entity's property and the property of any other fund.

In addition, the general law also imposes certain fiduciary duties on a responsible entity, in its capacity as a trustee, many of which are similar to those set out in the Corporations Act. These include:

  • Carrying out its duties and exercising its powers to the standard of an ordinary prudent business person or a higher standard for professional trustee companies.

  • Accounting to members in a timely, faithful and accurate fashion and providing them with information regarding the trust property.

  • Not binding themselves contractually to exercise a power in a prescribed manner.

  • Exercising care when selecting agents and supervising them.

  • Avoiding conflicts of interest.

AFS licence. Any entity that carries on a business of providing financial services in Australia must satisfy one of the following:

  • Hold an appropriate AFS licence. The responsible entity and manager (if applicable) of a retail fund are highly likely to be providing financial services and will therefore require an AFS licence with the appropriate authorisations.

  • As an alternative to holding an AFS licence, be able to rely on an appropriate licensing exemption.

  • Be the authorised representative of the holder of an appropriate AFS licence.

The holder of an AFS licence is subject to general obligations, including (under the Corporations Act):

  • Doing all things necessary to ensure that financial services are provided efficiently, honestly and fairly.

  • Having in place adequate arrangements for the management of conflicts of interests.

  • Complying with the conditions on the AFS licence.

  • Having adequate resources to provide those financial services.

  • Maintaining the competence to provide those financial services, including ensuring that its representatives are adequately trained and competent.

  • Having an external and internal dispute resolution process.

  • Having adequate risk management systems.

  • Having compensation arrangements for retail clients.

Disclosure. The offer of interests in a retail fund to retail clients will generally require certain disclosure documents to be prepared in accordance with the content requirements mandated by the Corporations Act, Corporations Regulations and ASIC policy and regulatory guidance:

  • Product Disclosure Statement (PDS), which must be given to the retail client:

    • at or before the time a recommendation is made to invest in a fund;

    • when an offer is made to issue or arrange the issue of interests in a fund; or

    • when a seller makes an offer to sell interests in a fund.

    The PDS must contain specific information as prescribed under the Corporations Act (for example, information about the responsible entity (and manager, if applicable), the fees and costs payable, the risks and benefits and significant characteristics of the fund). A PDS must also contain any other information that might reasonably be expected to materially influence the decision of a (reasonable) retail client in considering whether to invest in the fund.

    Funds that are "simple managed investment schemes" (defined by a liquidity test) must use a shorter PDS, although certain funds such as hedge funds are excluded from using a shorter PDS and having additional disclosure requirements.

    There are exceptions from the requirement to give a PDS, including in the case of small-scale offerings and offers to wholesale clients. However, in such circumstances in the absence of providing a PDS, it would be usual to provide another disclosure document, such as a private placement memorandum or an information memorandum.

  • Financial Services Guide (FSG), which must be given to the retail client before the financial service is provided and must contain information to help the retail client make an informed decision whether to acquire that financial product or service. An FSG is not required to be given by the operator of a fund if a PDS providing all sufficient information (see above) has already been given to a retail client.

Closed-ended retail funds

The managers and operators of closed-ended retail funds are subject to the same requirements as open-ended retail funds (see above, Open-ended retail funds).

Assets portfolio

7. Who holds the portfolio of assets? What regulations are in place for its protection?

Open-ended retail funds

Under the Corporations Act, the responsible entity of a registered managed investment scheme is required to:

  • Clearly identify fund property and hold fund property separately.

  • Hold fund property on trust for members of the fund. The responsible entity can appoint an agent to hold fund property separately from other property (that is, appoint a separate custodian while remaining responsible for the custodian's actions).

A responsible entity has strict liability for the acts of its agents. Responsible entities are also required to meet strict financial requirements, including by doing all of the following:

  • Be solvent and hold positive net assets.

  • Prepare a cash flow projection that covers a period of at least 12 months forward.

  • Meet special minimum net tangible assets (NTA) requirements, of the greater of A$10 million or 10% of average responsible entity revenue if the assets of the fund are not held by a custodian.

  • If the assets of the fund are held by a custodian who the responsible entity reasonably believes meets the financial requirements that apply to custodians (such as A$10 million NTA or 10% of average revenue for non-incidental custodians), have a minimum NTA of the greater of:

    • A$150,000;

    • 0.5% of the average value of fund property of the registered schemes the responsible entity operates up to a maximum of A$5 million; or

    • 10% of average responsible entity revenue.

  • Provide an audit report for each financial year that includes information about compliance with these financial requirements.

  • Hold cash and cash equivalent to the greater of A$150,000 or 50% of the required NTA and an amount of liquid assets equivalent to the required NTA.

There are extensive rules applicable to the:

  • Calculations of NTA.

  • Average responsible entity revenue.

  • SLF amounts.

Closed-ended retail funds

The custody requirements for closed-ended retail funds are regulated in the same manner as open-ended retail funds (see above, Open-ended retail funds).

Legal fund vehicles

8. What are the main legal vehicles used to set up a retail fund and what are the key advantages and disadvantages of using these structures?

Open-ended retail funds

Legal vehicles. Retail funds are predominantly structured as unit trusts, where each member holds units representing their beneficial interest in the fund's assets.

Advantages. The main advantage of the trust structure is tax efficiency (see Question 13).

Disadvantages. A retail fund is subject to relatively heavy regulatory requirements and therefore the costs and resources involved in complying with those regulatory requirements may be higher. The unfamiliar Australian terminology for retail funds (such as "responsible entity" and "managed investment scheme") can make Australian retail funds less attractive to offshore investors. In addition, offshore fund managers who want to market to Australian investors tend to have to set up an Australian retail feeder fund through which Australians investors can invest in an offshore fund, rather than directly marketing the offshore fund to Australian investors.

Lastly, compliance with trust law principles may make it more difficult to implement certain business decisions as any action taken in relation to a fund must be in the best interests of members (for details of general law requirements, see Question 6).

Closed-ended retail funds

The legal vehicles for closed-ended retail funds are the same as for open-ended retail funds (see above, Open-ended retail funds).

Investment and borrowing restrictions

9. What are the investment and borrowing restrictions on retail funds?

Open-ended retail funds

A responsible entity is restricted in its powers to invest and borrow on behalf of a retail fund by the following:

  • Constitution. The fund's constitution sets out the responsible entity's power to invest and/or borrow and may impose restrictions. However, the constitution may be drafted so as to provide the responsible entity with wide investment and borrowing powers (see below, General law).

  • AFS licence. The responsible entity's AFS licence must contain appropriate authorisations to facilitate the fund investing in various classes of assets (or "financial products").

  • Corporations Act. Where a financial benefit is given to a responsible entity or a related party, and the benefit is either given out of fund property or could endanger fund property, the related party provisions under the Corporations Act must be complied with. These require either:

    • member approval of the giving of the financial benefit; or

    • an exemption to apply (such as that the benefit is being given on arm's length terms).

  • General law. Under the general law, trustees have a duty to act in the best interests of members as a whole and to invest trust moneys in the manner authorised by the fund's constitution.

Closed-ended retail funds

Closed-ended retail funds are subject to the same investment and borrowing restrictions as open-ended retail funds (see above, Open-ended retail funds).

 
10. Can the manager or operator place any restrictions on the issue and redemption of interests in retail funds?

Open-ended retail funds

Restrictions can be placed on the issue and redemption of interests in retail funds. These must be set out in the fund's constitution and must be consistent with the Corporations Act and clearly disclosed in the PDS. When implementing such restrictions, the responsible entity should bear in mind:

  • Its duty under the Corporations Act to treat members of the same class equally and members of different classes fairly.

  • If the right to withdraw (if any) is exercised while the fund is liquid (that is, if liquid assets account for at least 80% of the value of fund property), the redemption must be implemented in accordance with the fund's constitution.

  • If the right to withdraw (if any) is exercised while the fund is not liquid, the redemption must be implemented in accordance with the Corporations Act (which specifies when and how a withdrawal offer can be made and what must be disclosed in the withdrawal offer) and the fund's constitution.

Closed-ended retail funds

Closed-ended retail funds are subject to the same restrictions as open-ended retail funds (see above, Open-ended retail funds).

 
11. Are there any restrictions on the rights of participants in retail funds to transfer or assign their interests to third parties?

Open-ended retail funds

There are no specific legislative restrictions on the rights of participants in retail funds to transfer or assign their interests to third parties. However, a fund's constitution may contain such restrictions and may provide the responsible entity with discretion to refuse a transfer. The exercise by the responsible entity of any discretion granted under the fund's constitution is subject at all times to the responsible entity's statutory and fiduciary duties. Any restrictions imposed under the constitution on transfer must be clearly disclosed in the product disclosure statement (PDS).

Funds listed on the Australian Securities Exchange (ASX) are also subject to the ASX's listing and operating rules and units in ASX listed funds are generally transferable.

Closed-ended retail funds

Closed-ended retail funds are subject to the same transfer and assignment restrictions as open-ended retail funds (see above, Open-ended retail funds).

Reporting requirements

12. What are the general periodic reporting requirements for retail funds?

Open-ended retail funds

Investors. The responsible entity for an unlisted retail fund must provide investors with the following:

  • Periodic statement. This must be provided for each reporting period (not exceeding a year) within six months after the end of the reporting period to which it relates. The periodic statement contains information that the responsible entity reasonably believes a member of the fund needs in order to understand their investment, including:

    • the opening and closing balances; and

    • details of transactions during the reporting period.

  • Annual financial report and directors' report. The following must be provided for each financial year:

    • a financial report, directors' report and auditor's report; or

    • a concise report setting out a concise financial report, directors' report, statement by the auditor and an offer to provide the full report.

  • Material changes and significant events. The responsible entity must, at any time, notify members of material changes and significant events in relation to the fund, including material changes and significant events that would have been required to be specified in the product disclosure statement (PDS). If the material change involves an increase in fees then at least 30 days' notice must be provided to members before the increase takes effect.

  • Continuous disclosure requirements. If a retail fund has 100 or more members, it must comply with continuous disclosure obligations (including an obligation to lodge a document with the Australian Securities and Investments Commission (ASIC) (or disclose on its website) containing information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of the interests in the fund (and was not included in the PDS)).

  • Confirming transactions. The responsible entity must provide members with confirmation of transactions in relation to their interests in the fund, including:

    • when they acquire the interest in the fund; and

    • when they dispose of all or part of their interests in the fund.

In addition, the responsible entity of a fund that is listed on the Australian Securities Exchange (ASX) must comply with the continuous and periodic disclosure requirements under the ASX Listing Rules.

Regulators. The responsible entity must lodge certain documents and reports with ASIC. These include:

  • Breach reports. The responsible entity must report any breaches of the Corporations Act that relate to the fund and have had, or are likely to have, a materially adverse effect on the interests of members. Further, if the responsible entity breaches, or is likely to breach key licensing obligations where the breach or likely breach is significant, it must report to ASIC within ten business days after becoming aware of the breach or likely breach.

  • Notification. The Corporations Act imposes a range of notification requirements, such as the obligation to notify ASIC when a PDS is in use or when a new authorised representative is appointed.

  • Lodgement. The responsible entity must lodge key documents with ASIC, both when the fund is registered and on an on-going basis, for example in the event of the fund amending the constitution or compliance plan.

  • Direction. ASIC may direct any AFS licensee (which would include the responsible entity of a registered managed investment scheme) to provide information.

The responsible entity also has reporting obligations under the AML/CTF Act, regulations and the AML/CTF Rules (AML/CTF Laws), which include providing AUSTRAC with:

  • An annual AML/CTF compliance report relating to the responsible entity's compliance with the AML/CTF Laws during the reporting period.

  • A suspicious matter report within the required timeframes, if the responsible entity forms a relevant suspicion for the purposes of the AML/CTF Act while dealing with a client.

  • An international funds transfer instruction report within ten business days after the day on which the responsible entity sends or receives an international funds transfer instruction to or from a foreign country for a transfer of money or property.

  • A threshold transaction report, within ten business days after the day on which the transaction takes place if the responsible entity provides a designated service to a client involving the transfer of physical currency or e-currency of A$10,000 or more.

Closed-ended retail funds

Closed-ended retail funds are subject to the same reporting requirements as open-ended retail funds (see above, Open-ended retail funds).

Tax treatment

13. What is the tax treatment for retail funds?

Open-ended retail funds

Funds. Most retail funds are structured as unit trusts. Unit trusts are generally managed so they can be treated as a "flow through" for tax purposes so that it is the investor and not the fund that is taxed. Investors are taxed on their share of the net tax income earned by the fund. This applies to:

  • Taxable income distributed to or reinvested by an investor.

  • Income that an investor is entitled to receive but has not been distributed by the fund.

Tax losses incurred by a unit trust do not flow through to the investors. Instead, they remain at the fund level and can be carried forward and set off against future income and gains if certain tests are met in respect of the fund's ownership and investments. Capital losses can only be set off against capital gains.

Flow through tax treatment does not apply to certain widely held unit trusts (known as public trusts) that control investments considered to be trading for tax purposes (known as trading trusts). Public trading trusts are taxed at fund level at the company tax rate (30%) and are treated as companies for most tax purposes. Trading trust tax treatment does not generally arise by reason of:

  • Investing or trading in debt and equity securities and derivatives.

  • Investing in commercial property for the purpose of deriving rent.

Stapled entities are used in some sectors, whereby trading activities are held by a company or public trading trust and other investments are held by a unit trust. The trading activities are generally taxed at the fund level and the remaining investments qualify for flow through tax treatment. Stapled entities are used in the real estate investment trust (REIT) sector, infrastructure, private equity and others.

In addition to the general trust provisions, Australian taxation law has specific rules that apply to eligible managed investment trusts (MIT) to encourage investment into Australia, especially Australian real estate. Broadly, a MIT is a widely held Australian trust that is operated by an AFSL holder and that undertakes specified investment activities. An eligible MIT may access the following tax concessions:

  • The fund may apply the capital gains tax (CGT) provisions as the primary code for taxing gains and losses on the disposal of eligible assets including company shares, trust units, land (including an interest in land and a right to acquire or dispose of any of these assets). This is relevant to qualifying for investor tax concessions (see below, Resident investors).

  • A concessional rate of withholding tax of 15% (rather than 30%) applies to "fund payments" made to non-resident investors who are tax resident in a jurisdiction that has an information exchange agreement with Australia (for example the Bahamas, British Virgin Islands, Cayman Islands, China, Japan, Singapore, UK and US).

A number of the tax consequences outlined above are contingent on whether the fund itself qualifies as a fixed trust. In light of recent case law, there is (technically) a risk that many funds do not qualify as a fixed trust unless the Australian Commissioner of Taxation exercises his discretion to treat them as such. The Australian government is currently reviewing the taxation of managed funds and trusts, including this issue.

As part of its review, a new tax regime for qualifying MITs referred to as Attribution MITs (AMITs) is being introduced. Broadly, an AMIT is a MIT whose members have clearly defined interests in relation to the income and capital of the fund. Under the new system, an AMIT will qualify as a fixed trust for tax purposes.

One of the key features of the tax regime is the opportunity for AMITs to adopt an attribution model of determining the tax liability for the trustee and the investors, rather than applying the tax law as it applies to trusts generally. Broadly, the attribution method is based on investors being subject to tax on the taxable income of the MIT that is allocated to them by the trustee on a fair and reasonable basis which is consistent with the MIT's constituent documents. See Tax update, for further details.

Australia has a VAT-style tax regime known as the goods and services tax (GST), with a general rate of 10%. This regime includes rules concerning the treatment of financial supplies that can limit the extent to which funds can recoup GST paid in relation to expenditure of the fund.

Resident investors. The tax treatment of income and capital gains for resident investors is broadly as follows:

  • Income. The fund usually calculates its net tax income, which is generally taxed in the hands of the investors in proportion to the distributions they receive. The net tax income can be different to the trust's net accounting income due to different treatment of income, gains and expenses for tax purposes compared with trust accounting purposes. Therefore, the amount distributed can exceed the amount of net tax income. This excess is commonly called a "tax-deferred distribution". Any tax-deferred distribution will reduce the cost base of the units in the unit trust in the hands of the investors for CGT purposes. Once the cost base reaches zero, further tax-deferred distributions are taxed in the hands of investors. If the net tax income attributable to an investor exceeds their share of the trust accounting income (and resulting cash distribution), the investor is nevertheless taxed on their full share of net tax income (including the excess).

  • Capital gains. Resident investors are usually taxable on capital gains and losses made on disposal of their units. Depending on the type of investor, the capital gains can qualify for discount capital gains treatment

Stamp duty is imposed on a state-by-state basis in Australia. Many funds are established in states with wide exemptions for duty on the transfer of units. However, duty can apply on the transfer of units in real estate holding funds, particularly those that are unlisted.

There is generally no GST payable on the issue, redemption or transfer of units in a fund.

Non-resident investors. The tax treatment of income and capital gains for non-resident investors is as follows:

  • Distributions of capital gains are generally not subject to tax in the hands of non-resident investors unless they are gains on taxable Australian property (that is, generally direct and indirect interests in land and mining interests).

  • Distributions of dividend, interest and royalties are subject to withholding tax. The amount of tax withheld will depend on the composition of the distribution and on any double tax agreements that may apply. Withholding tax generally does not apply to the franked dividend component of the distribution.

  • For distributions of income other than those discussed above, the rate of tax generally depends on whether the fund qualifies as a MIT. If the fund qualifies as a MIT, non-resident investors are generally taxed on distributions through a withholding tax of 15%, provided they are resident in a country with an exchange of information agreement (EOI) with Australia. Distributions to investors from countries with no EOI remain subject to a 30% rate of withholding.

    If the fund is not a MIT, distributions to non-resident investors of the fund's Australian source income is assessed to the trustee at higher rates (currently up to 47% for natural persons and 30% for companies). This is usually deducted by the trustee from the distribution.

  • The tax position of gains and losses made by non-resident investors on disposal of their units varies, depending on the nature of their investment. Investments on capital account are generally not taxed unless attributable to Australian real estate or used in carrying on a business through an Australian permanent establishment. Non-residents are not eligible for the discount on capital gains earned after 8 May 2012 on taxable Australian property. However, non-residents will still be entitled to a discount on capital gains accrued before 8 May 2012.

  • Broadly, the same rules apply to stamp duty and GST as for resident investors (see above, Resident investors).

Tax update

The Government had previously announced its intention to introduce a comprehensive regime for the taxation of MITs and following extensive industry consultation, has recently introduced draft laws on the taxation of AMITs. The commencement date of the taxation regime that will apply to AMITs is scheduled for 1 July 2016, with the option for AMITs to adopt an earlier start date of 1 July 2015.

Broadly, the taxation of AMITs will be governed by an attribution model that will require 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 tax character). Once the various trust components of particular tax 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 will issue a statement to each member advising them of that amount. Under the 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.

The tax law that currently applies to funds generally will not apply to AMITs. At the time of writing, the draft laws continue to progress through the Australian Federal Parliament.

Closed-ended retail funds

Funds. The rules for open-ended retail funds apply (see above, Open-ended retail funds: Funds).

Resident investors. The rules for open-ended retail funds apply (see above, Open-ended retail funds: Resident investors).

Non-resident investors. The rules for open-ended retail funds apply (see above, Open-ended retail funds: Non-resident investors).

Quasi-retail funds

14. Is there a market for quasi-retail funds in your jurisdiction?

There is no market for quasi-retail funds in Australia. Funds offered in Australia are either retail or wholesale.

In relation to UCITS funds (that is, undertakings for collective investment in transferable securities under Directive 2009/65/EC on undertakings for collective investment in transferable securities (UCITS) (UCITS IV Directive)) specifically:

  • UCITS funds cannot be offered directly to retail clients in Australia. Rather, anyone promoting a UCITS fund to Australian retail clients must establish a registered managed investment scheme as the Australian feeder fund into the UCITS fund.

  • A UCITS fund can only be offered directly to wholesale clients in Australia subject to the AFS licensing requirements (see Question 6, Open-ended retail funds: AFS licence).

Reform

15. What proposals (if any) are there for the reform of retail fund regulation?

There are a number of regulatory reforms proposed that will affect retail funds. For example:

  • The Australian Securities and Investments Commission (ASIC) has released updated guidance in Regulatory Guide 221 (Facilitating digital financial services disclosures) and has made instruments to facilitate electronic delivery of financial services disclosure and to remove barriers to electronic disclosure. The purpose of the updated guidance and instruments is to facilitate default electronic delivery of financial services disclosures and to enable the use of more innovative product disclosure statements.

  • On 24 November 2015, ASIC released updated guidance on fee and cost disclosure for responsible entities of managed funds and other investment schemes and trustees of superannuation funds. The updated guidance consisted of updated ASIC regulatory guidance on fee and cost disclosure and a modification to an existing ASIC relief instrument. Most significantly, the updated guidance provides that the costs of investing through an interposed vehicle or chain of interposed vehicles must be disclosed as part of the management costs of the fund in a retail disclosure document (PDS).

  • The pilot of the Asia Region Funds Passport (ARFP) is expected to commence in 2016, with Australia, South Korea, New Zealand and Singapore comprising the initial pilot participants. The ARFP is aimed at facilitating cross-border distribution of managed fund products across the Asia region, by allowing collective investment products offered in one passport economy to be sold to investors in another economy.

  • Work continues on the introduction of a comprehensive Australian collective investment vehicle (CIV) regime, which will provide Australian fund managers with a suite of new investment structures with global recognition. In June 2015, the Treasury released the long awaited Board of Taxation report into the CIV regime. The report recommended that a suite of different forms of CIVs be introduced, which broadly apply the same tax flow-through treatment as unit trusts provided they meet certain conditions. Subsequently, there has been a period of Treasury consultation with industry to rationalise and prioritise the suite of potential investment vehicles. There has also been a push by industry to have the CIV measures taken out of the tax white paper process to expedite their progress to better align with the Asia Region Funds Passport.

  • On 20 October 2015, the Hon Scott Morrison (Treasurer) and the Hon Kelly O'Dwyer (Minister for Small Business and Assistant Treasurer) released the Government's response to the Final Report of the Financial System Inquiry. The Final Report had contained 44 far-reaching recommendations relating to the Australian financial system and how it can best meet Australia's evolving needs and support Australia's economic growth. It is intended that the recommendations will foster an efficient, competitive and flexible financial system, consistent with financial stability, prudence, public confidence and capacity to meet the needs of users. Five distinct strategic priorities emerge from the Government's response, in which it agreed with all bar one of the 44 recommendations:

    • resilience;

    • superannuation and retirement incomes;

    • innovation;

    • consumer outcomes; and

    • the regulatory system.

    The Government is now in the process of consulting on many of the recommendations and aims to introduce many reforms by mid to late 2016.

 

Hedge funds

16. What is the structure of the hedge funds market? What have been the main trends over the last year?

With A$95.9 billion of assets under management, Australia's hedge fund manager market is the second largest in the Asia Pacific region after Hong Kong and consists of single-manager hedge funds and funds of hedge funds (Source: Australian Securities and Investments Commission Report 439: Snapshot of the Australian hedge funds sector, July 2015).

Investors in Australian hedge funds consist of (in order of size):

  • Mostly retail and high net worth individuals.

  • Australian institutional investors.

  • Offshore institutional investors.

Regulatory framework and bodies

17. What are the key statutes and regulations that govern hedge funds in your jurisdiction? Which regulatory bodies regulate hedge funds?

Hedge funds are subject to the same statutes and regulations as open-ended retail funds (see Question 2, Open-ended retail funds).

 
18. How are hedge funds regulated (if at all) to ensure compliance with general international standards of good practice?

Hedge funds are subject to the same regulation as open-ended retail funds (see Question 3, Open-ended retail funds).

Regulatory Guide 240: Hedge funds: Improving disclosure (RG 240) introduces specific disclosure requirements for hedge funds, as defined by the Australian Securities and Investments Commission (ASIC).

RG 240 took effect from June 2013 (see Question 28, Open-ended retail funds).

Marketing

19. Who can market hedge funds?

Hedge funds are subject to the same rules for marketing as open-ended retail funds (see Question 4, Open-ended retail funds).

 
20. To whom can hedge funds be marketed?

Hedge funds are subject to the same rules for marketing as open-ended retail funds (see Question 5, Open-ended retail funds).

Investment restrictions

21. Are there any restrictions on local investors investing in a hedge fund?

There are no restrictions on local investors investing in a hedge fund.

Assets portfolio

22. Who holds the portfolio of assets? What regulations are in place for its protection?

Hedge funds are subject to the same custody arrangements as open-ended retail funds (see Question 7, Open-ended retail funds).

Requirements

23. What are the key disclosure or filing requirements (if any) that must be completed by the hedge fund?

Hedge funds are subject to the same disclosure/filing requirements as open-ended retail funds (see Question 12, Open-ended retail funds).

In addition, RG240 provides specific disclosure requirements for hedge funds, as defined by the Australian Securities and Investments Commission (ASIC), from June 2013.

 
24. What are the key requirements that apply to managers or operators of hedge funds?

Hedge funds are subject to the same requirements as open-ended retail funds (see Question 6, Open-ended retail funds).

Legal fund vehicles and structures

25. What are the main legal vehicles used to set up a hedge fund and what are the key advantages and disadvantages of using these structures?

The same legal vehicles for open-ended retail funds apply to hedge funds (see Question 8, Open-ended retail funds). The same advantages and disadvantages are also applicable.

Tax treatment

26. What is the tax treatment for hedge funds?

Hedge funds are subject to the same tax treatment as open-ended retail funds (see Question 13, Open-ended retail funds).

Restrictions

27. Can participants redeem their interest? Are there any restrictions on the right of participants to transfer their interests to third parties?

Hedge funds are subject to the same rules for redemption as open-ended retail funds (see Question 12, Open-ended retail funds).

Reform

28. What (if any) proposals are there for the reform of hedge fund regulation?

There are no specific reforms currently proposed in relation to the regulation of hedge funds.

 

Online resources

Australian Securities and Investments Commission

W http://asic.gov.au/asic/asic.nsf

Description. Official website for the Australian corporate regulator, the Australian Securities and Investments Commission (ASIC). This website contains the latest updates to retail fund regulation.

Treasury Department

W www.treasury.gov.au

Description. Official website for the Commonwealth Treasury. This website contains the latest updates to retail fund regulation.



Contributor profiles

Nikki Bentley, Partner

Henry Davis York

T +61 2 9947 6245
F +61 2 9947 6999
E nikki.bentley@hdy.com.au
W www.hdy.com.au

Professional qualifications. New Zealand, Lawyer, 1996; Australia, Lawyer, 2001

Areas of practice. Investment Funds, financial services regulation, business establishment and structuring, product development, product disclosure, distribution and compliance.

Non-professional qualifications. LLB

Lucinda McCann, Partner

Henry Davis York

T +61 2 9947 6070
F +61 2 9947 6999
E lucinda.mccann@hdy.com.au
W www.hdy.com.au

Professional qualifications. Australia, Lawyer, 1998

Areas of practice. Investment funds; financial services regulation; product development; product disclosure; financial markets and derivatives.

Non-professional qualifications. BA (Hons), LLB, LLM, Grad Dip Legal Practice

Greg Reinhardt, Partner

Henry Davis York

T +61 2 9947 6452
F +61 2 9947 6999
E greg.reinhardt@hdy.com.au
W www.hdy.com.au

Professional qualifications. Australia, Lawyer, 1999

Areas of practice. Tax

Non-professional qualifications. BEC (Accounting), LLB, LLM


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