January 16, 1992
TO: INTERNATIONAL MEMBERS NO. 2-92
RE: INTERNATIONAL DEVELOPMENTS IN INVESTMENT COMPANY TAXATION
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This memorandum summarizes recent international tax
developments regarding investment company taxation.
1. Australia: Proposal on the Taxation of Foreign
Investment Funds.
The introduction of a proposed tax regime to deal with
deferral of Australian tax on passive income derived from foreign
entities which are not controlled by Australian residents has
been postponed. The foreign investment fund ("FIF") rules had
been scheduled to become effective July 1, 1991, but legislation
is now not expected to be introduced until March or April 1992,
to take effect July 1, 1992.
Under the proposal, which is similar to the United States'
"passive foreign investment company" or "PFIC" rules, all income
and gain derived from offshore interests would be taxable
currently in Australia unless one of three exemptions apply. The
first exemption would be for persons with de minimis holdings,
defined as persons whose total foreign holdings total (A)$20,000
or less. (It is unclear whether the (A)$20,000 refers to market
value or cost basis.)
The second exemption would apply to persons who are
"attributable taxpayers" under the "controlled foreign
corporation" or "CFC" rules, which generally mirror the United
States' CFC rules. A controlled foreign corporation is generally
one in which five or fewer Australian residents own fifty percent
or more of a foreign company. An attributable taxpayer would be
one who is a ten percent or greater owner in a CFC. Thus, a
person who is a less than ten percent owner of a CFC would be
subject to the FIF regime, whereas a greater than ten percent
owner would be under the CFC rules.
The third exemption would be for interests in most
companies which are primarily engaged in active businesses. The
FIF regime would not apply to less-than-10-percent shareholders
in a foreign company engaged primarily in an active business so
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long as the company's stock is listed on an established exchange.
For 10-percent-or-greater holders, the foreign company would not
need to be listed for the exclusion from the FIF regime to apply,
so long as the company is primarily engaged in an active
business.
Holders of interests in FIFs would be taxed on a mark-to-
market system. Where market value information is unavailable, a
deemed rate of return would be used to calculate the tax on the
FIF. Provisions would be made to prevent double taxation where
FIFs make distributions. It is unclear whether the proposal will
provide for basis adjustments for distributions or modify the
availability of capital gain treatment on disposition.
2. France: Increased Tax Rate on Capital Gains on Mutual
Funds Organized as Corporations.
The French Parliament has adopted a portion of the
government's proposed 1992 tax bill. The legislation now goes to
the Senate for discussion, which usually does not affect the
bill's enactment. As part of the bill, rates on long term
capital gains derived from "placement securities" was increased
to the general capital gain rate of 34 percent. Previously,
capital gain on placement securities had been 25 percent.
Placement securities are defined to include the shares of French
mutual funds organized in corporate form (such as SICAVs).
3. France: Tax Relief for Merging Investment Funds.
Two principal fund types exist in France: the incorporated
form, know as a SICAV (which is an open-end investment company)
and the unincorporated form, known as a "Fond Common de
Placement" or "FCP". Under French corporate law, either type of
fund may merge into the other or into a fund of the same type.
However, prior to the change in the tax law, only two SICAVs
could merge without adverse tax consequences, as both were
corporations. Mergers of a SICAV with an FCP or of two FCPs
could result in tax to both the investors and the funds. The
exchange of SICAV shares or FCP units for interests in the
surviving fund was treated as a realization event for tax
purposes and the shareholder was deemed to have recognized
capital gain to the extent of the difference in value between the
original cost of the shares or units and the value at the time of
the merger.
The new provisions allow individuals holding shares of a
SICAV or units of an FCP which is merged into another fund to
postpone any capital gain arising as a result of the exchange of
their shares or units by "rolling over" their cost basis in their
original shares to their new shares and treating the original
cost as the cost of the new shares. Thus, when the new shares
are ultimately disposed of, the gain on the original shares will
be preserved and recognized at the time of disposition.
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Tax relief for the funds themselves is dependent on the
accounting treatment of the securities acquired from the target
fund. Essentially, the surviving fund can avoid gain recognition
by rolling over the cost basis of the securities it receives in
the merger from the target fund. The tax is then collected when
the fund ultimately sells the securities. In addition, because
French funds are exempt from tax on ordinary income and capital
gain, and investors pay tax only when the income is distributed
or their shares sold, the provisions allow undistributed income
of the target fund to remain untaxed until it is distributed by
the surviving fund.
The effective date of these provisions is retroactive to
January 1, 1990, for individual investors, and to taxable years
ending after December 31, 1990 for funds.
4. United Kingdom: New Rules on Transactions in Financial
Options and Futures by Investment Trusts
Previously the Institute informed you that the Inland
Revenue was modifying the Statement of Practice regarding the
treatment of financial options and futures transactions engaged
in by investment funds in order to help taxpayers determine when
such transactions are "investment transactions" and when they are
"trading" in securities. (See Institute Memorandum to
International Committee No. 13-91, dated July 11, 1991.) The
Inland Revenue has now released this document in final form.
The Statement of Practice is of relevance both to U.K.
resident investment vehicles such as investment trusts (the
closed end, corporate form of fund) and unauthorized unit trusts,
and to non-resident collective investment vehicles, both open-
and closed-end. For resident investment vehicles, the
distinction between investment transactions and trading is
important because investment transactions give rise to capital
gain, which is not taxable to the fund and does not need to be
distributed, while trading transactions result in ordinary income
which must be distributed annually. A non-resident fund which is
trading may not have "distributor status" under the U.K. offshore
funds legislation, which would mean that a U.K. resident investor
in such a trading fund would be required to treat gain on the
disposition of the fund's shares as ordinary income, rather than
as capital gain eligible for inflation indexing adjustments and
the annual 5,000 pound exclusion for capital gains.
Basically, the Statement of Practice provides that
financial futures or options transactions (including foreign
currency futures contracts) legitimately entered into to minimize
risk of loss and ancillary to another transaction will be
considered investment transactions provided that the transaction
to which the financial future or option relates is capital in
nature. If a financial future or options transaction is not
ancillary to another transaction, the future or option
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transaction itself must be analyzed to determine whether it
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itself is an investment transaction or is trading. Such a
determination depends on the facts of the particular transaction.
5. Belgium: Dividend Withholding Abolished
As the Institute reported in an earlier memorandum (see
Institute Memorandum to International Committee No. 13-91, dated
July 11, 1991), Belgium passed legislation dealing with the
taxation of investment funds which generally mirrors that of
France and Luxembourg. However, the legislation provided for a
25 percent withholding rate on distributions from Belgium funds,
in the infrequent event that the funds choose to make a
distribution, making the Belgian funds relatively unattractive
compared to funds organized in other countries which had no
withholding on distributions.
This withholding tax has recently been repealed with
respect to distributions to foreigners from qualified investment
funds. The exemption does not require any minimum holding period
or amount, nor is it limited to shareholders who are resident in
a European Community member state. The exemption does not,
however, apply to the portion of the distribution derived from
dividends from Belgian corporations. The exemption is effective
retroactively for all distributions made on or after January 1,
1991.
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We will keep you informed of developments.
David J. Mangefrida Jr.
Assistant Counsel - Tax