Friday, February 15, 2008

Foreign Investment Fund Rules

In my post about the Man fund I'm thinking of investing in, I briefly mentioned Australia's foreign investment fund (FIF) rules. I think I now understand exactly how these apply.

The point of the rules is supposed to be to reduce tax avoidance. Without these rules, I could channel all my savings into an offshore hedge fund. If the hedge did not pay out distributions but instead retained all earnings there would be no distributions to tax under the regular tax code. Then I could retire and move out of Australia and because Australia only really taxes Australian residents rather than Australian citizens I could avoid ever paying Australian tax on the funds earnings. The solution the Australian Tax Office came up with is to require investors in foreign investment funds to pay tax on the unrealised gains of their foreign investment funds annually. The problem with this is that it eliminates the possibility of applying the lower long-term capital gains tax rate to these investments and also requires you to pay tax now on income you may only actually be able to receive in the future.

Luckily there are plenty of exceptions to this draconian legislation that incidentally provides nice protection to Australian fund managers whose funds are not subject to such a tax rule.

First, pretty much any investment in a foreign company or fund that is not registered or listed in Australia qualifies as a foreign investment fund. Yes, all foreign shares are counted as "foreign investment funds". But all "active businesses", US regulated investment funds, and foreign employer sponsored retirement plans are exempt (i.e. unlisted hedge funds and non-US investment funds of all types are not exempt). If you have less than $A50,000 of such foreign investments (including retirement plans) you are also exempt from the legislation. All my existing foreign investments are exempt (US mutual funds, US stocks, Belgian stock, and a US employer sponsored retirement plan (403b at TIAA-CREF)). I have well over $A50,000 of such investments.

But unfortunately the Man fund is not exempt as it is an unlisted fund based in the Cook Islands. There is, however, another exemption that can be used. If less than 10% of your total FIF investments (not counting employer sponsored funds) are of the non-exempt variety then those non-exempt ones are also exempt - this is called the "well balanced portfolio exemption". We have about $US59k in FIFs not counting my 403b. This means that currently we could invest up to $A7,000 in the Man fund and not be affected by the FIF legislation. Of course I could increase my exempt FIF holdings by using every last dollar of cash and available margin in my foreign accounts and then be able to invest more in the Man fund :)

What I don't understand is why they don't make this fund offered to Australian investors, an Australian resident fund.

1 comment:

Poly Muthumbi said...

Investing Your Money in Fixed Assets Will Talk More of Your Financial Position. Your assets are one half of the equation of your wealth and understanding the impact of each type of asset to your financial circumstances and future is important. With such knowledge, you can then make informed decisions about how and where you spend your money. List down your assets in the appropriate category today and begin the walk towards financial freedom.

Poly Muthumbi is a Web Administrator and Has Been Researching and Reporting on Debt for Years. For More Information on FINANCIAL BELIEFS, Visit Her Site at INVESTING YOUR MONEY