Foreign Investment Fund exemption and foreign hybrid

Is the foreign investment fund (FIF) income that is included in the net income of a partnership included in the taxpayer's assessable income under section 529 of the Income Tax Assessment Act 1936 (ITAA 1936) to the extent of the taxpayer's individual interest of the net income of the partnership?

No. The FIF income that is included in the net income of a partnership is not included in the taxpayer's assessable income because it is exempt under section 519B of the ITAA 1936.

The taxpayer is a resident of Australia for Australian taxation purposes and is a pooled superannuation trust (PST) as defined in the Superannuation Industry (Supervision) Act 1993 .

The taxpayer invests in United States (US) and European companies through a US Limited Liability Company (US LLC). The US and European companies are not controlled foreign companies of the taxpayer.

US LLC is a foreign hybrid company under section 830-15 of the Income Tax Assessment Act 1997 (ITAA 1997).

US LLC has two shareholders. The taxpayer has 99% contributed capital while the other shareholder, the manager, has 1% contributed capital. The manager is a foreign resident for Australian tax purposes.

US LLC is incorporated in the US and the management and control also takes place in the US. All relevant investment and management decisions and all legal and compliance obligations are undertaken by the manager of the US LLC in the US.

The net partnership income of US LLC includes FIF income.

As a foreign hybrid company under subsection 830-15(1) of the ITAA 1997, US LLC is treated as a partnership for Australian taxation purposes based on the operation of section 830-20 of the ITAA 1997. As a result, the normal partnership provisions of Division 5 of Part III of the ITAA 1936 will apply to the US LLC, subject to any special rules set out in Division 830 of the ITAA 1997.

Section 830-25 of the ITAA 1997 also provides that the existing shareholders in US LLC will become the partners of US LLC. Accordingly, both the taxpayer and the manager of US LLC will be the relevant partners of US LLC for the purposes of applying the ITAA 1936 or ITAA 1997.

Section 90 of the ITAA 1936 provides that the net income of a partnership means all the assessable income of the partnership, calculated as if the partnership were a resident taxpayer, less allowable deductions except for deductions allowable under section 82AAT of the ITAA 1936 or Division 36 of the ITAA 1997.

Assessable income includes any foreign investment fund (FIF) income that accrues to a taxpayer (section 529 of the ITAA 1936). However, for section 529 to apply (the operative provision) section 485 must also be satisfied.

Section 485 of the ITAA 1936 provides that section 529 of the ITAA 1936 will apply where there is a FIF, the taxpayer had an interest in a FIF at the end of the income year, the income year is the 1992-1993 income year or later, and the taxpayer is a 'Part XI Australian resident' at any time in that year of income.

A 'taxpayer' is defined in subsection 6(1) of the ITAA 1936 as 'a person deriving income or deriving profits or gains of a capital nature'. This would encompass a partnership, as there is no requirement in the definition to have a liability for taxation.

A 'Part XI Australian resident' is defined by reference to the definition of 'resident' under subsection 6(1) of the ITAA 1936. Although the definition of 'resident' in subsection 6(1) does not include a reference to a partnership, section 485A of the ITAA 1936 ensures that a partnership can be regarded as Part XI Australian resident for the purposes of applying section 485 and section 529 of the ITAA 1936. Subsection 485(1) further provides that section 485A also has effect when section 529 is applied to work out the net income of a partnership.

Due to the interactions between sections 485, 485A and 529 of the ITAA 1936, US LLC will be considered a 'taxpayer' - that is, a Part XI Australian resident, and accordingly, it is possible for US LLC to have an interest in a FIF, and to have FIF income included in its net income.

Although US LLC will be considered a taxpayer for the purposes of applying the FIF rules to include an amount in its net income, it will not be liable for taxation. The liability for taxation will rest with the Australian partner of US LLC on its share of the net income. In this case, the taxpayer's share of any FIF income (which is included in the net income of US LLC) is 99%.

Division 11A of Part XI of the ITAA 1936 exempts taxpayers who are trustees of complying superannuation entities from taxation under the FIF measures by ensuring the operative provision (that is, section 529 of the ITAA 1936) does not apply to the taxpayer in relation to a FIF (see subsection 519B(2) of the ITAA 1936).

As a trustee of a 'pooled superannuation trust' is defined in the Superannuation Industry (Supervision) Act 1998 , the taxpayer is a trustee of a complying superannuation entity. Paragraph 519A(b) of the ITAA 1936 exempts taxpayers who are trustees of complying superannuation entities from taxation under the FIF measures in respect of FIF income. Division 11A does not require the taxpayer claiming the exemption to hold the FIF interests in the relevant FIF.

Accordingly, the taxpayer is entitled to claim the FIF exemption under Division 11A for the FIF income that would otherwise be included in its assessable income, even though the FIF interest is held by US LLC.