Greater clarity for investors, but some issues remain unresolved
Major changes to Australia's foreign investment laws — commonly known as the 'FIRB regime' — came into effect on 1 January 2021. At about the same time the Australian Government released new FIRB guidance notes covering the new regime. The regime is set out in the Foreign Acquisitions and Takeovers Act 1975 (Cth) and Foreign Acquisitions and Takeovers Regulation 2015 (Cth).
On 21 July 2021, the Government released updated FIRB guidance notes which, according to the Government, 'aims to provide greater clarity to investors about their obligations under the foreign investment framework, including by addressing a number of issues identified since major reforms to the framework commenced on 1 January 2021'. The updated guidance notes are available here.
We agree that the updated guidance notes provide some clarity to investors and do address a number of issues, and this is highly welcomed. However, certain positions taken in the updated guidance notes will present practical difficulties and there are various issues which remain unresolved.
In this Insight we summarise and comment on the key changes to the FIRB guidance notes.
Summary of changes to the FIRB regime guidance notes
Passive FGI exemption certificate
- Under the FIRB regime, a person is deemed to be a 'foreign government investor' (FGI) where the person is a corporation, trustee of a unit trust or general partner of a limited partnership and either:
- FGIs from one country collectively have a 20% or greater interest in the corporation, unit trust or limited partnership; or
- FGIs from more than one foreign country collectively have a 40% or greater interest in the corporation, unit trust or limited partnership.
- A number of investment funds, in particular private equity and infrastructure funds, are considered to be FGIs as their investors are or include FGIs such as sovereign wealth funds and public pension funds, even though such investors are often passive and not involved in the management of the funds in which they invest. This means such funds' investments in Australia are generally subject to a nil monetary threshold for FIRB purposes.
- On 1 January 2021, as part of other changes to the FIRB regime, a new passive investor exemption for FGIs was introduced. Under the exemption, where an investment fund is an FGI because of the 40% test mentioned above and where various 'passive investor criteria' are met (being that individual investors in the fund are not able to influence any individual investment decisions, or the management of any individual investments, of the corporation, trustee or general partner under the fund), such an investment fund would no longer be deemed an FGI and instead would be subject to the FIRB thresholds applying to other foreign persons. Although a case-by-case analysis is required, we expect most private equity and limited partnership funds have been structured in line with ILPA Principles, which reflects this position.
- However, the changes did not address a situation where an investment fund was an FGI because of the 20% test mentioned above. The Government had flagged it would establish a new exemption certificate (EC) pathway to allow such investment funds to be treated like other foreign persons where the passive investor criteria mentioned above is satisfied. FIRB Guidance Note 9 has been updated to include this new policy.
Why is this important?
- Despite the new passive investor exemption introduced on 1 January 2021, many investment funds still find themselves to be FGIs and subject to the special FGI rules in the FIRB regime. For example, where sovereign wealth funds and public pension funds from the same country collectively have a 20% or greater interest in the fund. Often these sovereign wealth funds and pension funds are investing independently of each other.
- A PE fund often makes a strategic acquisition of a portfolio company and then seeks to grow that business through 'bolt-on' acquisitions. Being subject to a nil monetary threshold for FIRB purposes may put these PE funds at a competitive disadvantage in a sale process by increasing uncertainty, delays and transaction costs. This is even against non-FGI foreign investors for whom FIRB monetary thresholds may apply, as those foreign investors may not need FIRB approval depending on the nature of the target assets.
- The grant of an EC to put an investment fund in the same position as other foreign persons means that many global deals which would otherwise require FIRB approval because of the FGI rules will no longer be subject to a mandatory FIRB approval requirement and not hold up global closings. The investment fund will instead be subject to the voluntary FIRB approval rules like other foreign persons acquiring indirect interests in Australian entities via an offshore transaction.
- A special EC for investment funds overcomes the limitations of a normal business EC, which has financial caps on investments, a usual term not exceeding three years and carve-outs for various types of assets (such as data-driven businesses and public infrastructure). Such limits do not apply to non-FGI foreign persons under the FIRB regime. A normal business EC, whilst an improvement on the usual FGI rules, is still limiting for investment funds.
What does the new EC do?
- According to FIRB Guidance Note 9, the purpose of the new EC pathway – informally known as a 'passive FGI EC' – is to grant an investor access to the higher FIRB monetary thresholds that apply to non-FGI foreign persons. Note that this still means a nil monetary threshold for FIRB purposes applies in relation to national security businesses and national security land.
- A passive FGI EC can be granted for a specified period, including up to the life of a fund and may be subject to conditions. FIRB Guidance Note 9 acknowledges that a typical closed ended fund has a 10-year life plus 2-year potential extension, and typically a 4-to-7-year investment period.
- Both open and closed-ended funds will be considered, though the Government notes it may be easier for closed-ended funds to establish the passivity of their FGI investors.
- An essential condition to eligibility for a passive FGI EC is that the passive investor criteria mentioned above is satisfied. It is expected that most PE funds will satisfy this.
- An investment fund is not limited to applying for a passive FGI EC at the commencement of a fund. FIRB Guidance Note 9 states that the Treasurer will consider an application at any stage during a scheme's life. An example is given of a new 20%+ FGI investor coming into a fund halfway through an initial fundraising period, which would cause the fund to be an FGI. It is open to the fund to apply for a passive FGI EC at this point in time.
- Changes in ownership of an investment fund will not affect the validity of a passive FGI EC, unless a new FGI acquires a 20% or greater interest in the fund (except where FGIs from the same country already have a collective 20% or greater interest in the fund). In those circumstances, the fund will need to apply for a new passive FGI EC.
- As the objective of passive FGI EC is to put the relevant investment fund in the same position as other foreign persons, a passive FGI EC will not have any investment caps (unlike a normal business EC).
- The new passive FGI EC pathway will be administered by the Government using the mechanics in the existing FIRB legislation, rather than by amending the legislation. As a result, an application will need to be made for all of the categories of exemption certificates (ie businesses and entities exemption certificate, Australian land exemption certificate and tenements and mining production or exploration entities certificate). Whilst this may sound complicated, in practice it will not be because there is no need to provide details of proposed investments that are below the FIRB approval threshold for non-FGI foreign persons. In theory, this should streamline the application process.
- Investors should note that the grant of a passive FGI EC is not automatic. FIRB Guidance Note 9 states that applications for passive FGI ECs will be assessed on a case-by-case basis. This simply reflects the Treasurer's ability to make decisions on national interest grounds, including considering the character of the investor.
- It remains to be seen how parallel fund structures are dealt with. For those structures, it would be preferable for a single passive FGI EC to apply (and a single fee paid) for all vehicles which are considered part of the same overall fund, and also for FGI status to be assessed on an overall fund basis rather than on a vehicle-by-vehicle basis. It is a positive signal that the Government has indicated it is open to considering how to accommodate this – FIRB Guidance Note 9 states that, 'In considering applications for exemption certificates from investment funds (which comprise investment vehicles), regard may be given to the overall composition of the investment fund and its operation as a single economic entity'.
- A fixed $50,200 application fee is payable on a passive FGI EC. But note that an EC, once granted, can be for the life of a fund.
- ECs generally take longer to process than applications for FIRB approval.
Starting to carry on a national security business
- Under the FIRB regime, a foreign person needs FIRB approval to start to carry on a national security business or to acquire a 'direct interest' (usually 10% or more) in an entity that carries on a national security business.
- One of the conditions for a business being a 'national security business' is that the business is carried on wholly or partly in Australia whether or not in anticipation of profit or gain. In assessing whether a transaction triggers a FIRB approval requirement on 'national security business' grounds, a threshold question therefore is whether the target carries on a business in Australia.
- In the updated FIRB Guidance Note 8, it is stated that a 'business would generally be expected to have a presence in Australia or some form of connection to Australia to be considered a national security business' and that various factors may be considered for this purpose, such as:
- a physical presence in Australia, such as locally engaged employees or a lease of office space;
- the need for regulatory approvals to operate in Australia, such as the requirement to have an Australian Business Number;
- whether the business is required to comply with Australian law;
- the payment of tax in Australia;
- whether the business receives payments into an Australian bank account for goods and services rendered;
- the terms of the contract, such as requirements to undertake certain steps in Australia;
- using an agent in Australia to assist with some aspect of its business activities; and
- a website with a .au domain.
- If the purpose of the above is to provide clarity to investors then, with respect, the opposite has been achieved.
- Firstly, the above factors are just indications and not an exhaustive list. It is not clear whether a business is a national security business merely because any of the above factors is present.
- Secondly, and more importantly, the Government has, via FIRB guidance notes rather than legislation, expanded on how common law and the Corporations Act 2001 (Cth) approaches the question of whether a person is carrying on a business in Australia. The updated FIRB Guidance Note 8 (as well as FIRB Guidance Note 7) states that 'some form of connection to Australia' is sufficient, which is contrary to the Corporations Act which specifies that various forms of connection to Australia are not, on their own, sufficient to result in a company carrying on business in Australia. For instance, the Corporations Act provides that merely maintaining an Australian bank account is not sufficient, whereas the FIRB guidance notes say that receiving payments into an Australian bank account could be sufficient.
- The updated FIRB guidance also suggests that if a business is required to comply with Australian law, this is sufficient to result in that business carrying on a business in Australia. This would capture every person who exports goods or services to Australia from overseas and needs to comply with Australian laws in relation to such exports.
- Another factor given in the FIRB guidance is a contractual requirement to undertake certain steps in Australia. This is vague and unreasonably broad. A similar concern arises with the use of an agent in Australia to assist with business activities. There is no discussion of who can constitute an 'agent'. For instance, it is not clear whether an independent contractor can be safely excluded as an agent (in contrast, the Corporations Act states that using an independent contractor in Australia is not, on its own, sufficient to be taken to carry on a business in Australia).
- The practical consequence of the updated FIRB guidance is that foreign investors and their advisers might feel compelled to take conservative views, resulting in higher volumes of FIRB approvals being sought for acquisitions of interests in foreign companies that merely export to Australia from overseas. It could also result in the cessation of exports of goods and services to Australia by offshore targets where revenue from Australian customers is not material, and where the target and purchaser wish to complete a transaction without being subject to a FIRB approval requirement. This would not be in Australia's national interest.
Starting a national security business due to change in activities
- Under the FIRB regime, a foreign person who already carries on a national security business is not taken to start a national security business merely because they establish a new entity that carries on the same national security business. The converse is that undertaking a new business activity could be the starting of a national security business.
- FIRB Guidance Note 8 has been updated to state that the new business activity would generally need to be sufficiently different from activities already carried out to be considered to be starting a national security business. Various factors have been included to assist with the analysis:
- whether the new activity is in a different division under the ANZSIC Codes, noting changes in activity within ANZSIC codes may still constitute starting a national security business;
- whether new licences or approvals are required;
- whether new employees with different skillsets need to be engaged;
- entering into business contracts or investment in a new product or service that is not incidental to the current business activity; or
- the new activity results in a materially different product, input or service than previously provided.
- The additional guidance is welcome, however in many cases it will be a judgement call on whether a new national security business is started if a new activity comes within the same ANZSIC code, or whether a new product or service is 'incidental' to a current business activity.
National security land - Defence premises
- The term 'national security land' is defined to include ‘defence premises’ within the meaning of section 71A of the Defence Act 1903 (Cth), which includes all land owned or occupied by Defence.
- FIRB Guidance Note 8 has been updated to provide that Defence is only taken to occupy land if it has the legal right to use the land at the exclusion of others, at the time when the foreign investor is acquiring the interest in the land, and the mere presence of Defence on the land will not amount to occupation. In addition, buildings that are owned by the Defence Housing Authority are not considered to be defence premises under the foreign investment framework. This is a welcome development as it means land on which Defence merely has a licence to use is not considered national security land.
National security land – interests of national intelligence agencies
- The term 'national security land' is also defined to include land in which an agency in the national intelligence community has an interest that is publicly known or could be known upon the making of reasonable inquiries.
- FIRB Guidance Note 8 has been updated to provide that 'interest' in this context has a broad meaning – it means concern or involvement and is not limited by the legislative definition of interest in Australian land. For example, if ASIO had a one-year lease in respect of land, that is sufficient to constitute an 'interest' (whereas otherwise a lease needs to be greater than five years to constitute an interest in land). Alternatively, if ASIO merely has a licence in respect of land, that also constitutes an 'interest'. Note that this differs to the Government's approach regarding defence premises, where a licence over land is insufficient to constitute defence premises.
National security land – lease over part of land
- Given the breadth of the 'national security land' definition, it had previously been assumed that if a foreign person acquired a leasehold interest in part of a parcel of land where a national intelligence agency had an interest in another part of the land, then the foreign person was taken to acquire an interest in national security land.
- However, in a welcome development, FIRB Guidance Note 8 now provides that, with respect to acquisitions of land under a lease, the interest in land will be determined by what is being acquired on that title. For example, where a person obtains FIRB approval to acquire a lease over one floor in an office building, the approval covers just that leasehold interest and not the entire building. Similarly, where an agency in the national intelligence community has an interest in a portion of land under one title, it is only that portion of land that is national security land. This means a foreign person can acquire an interest in a different portion of land under the same title without that constituting the acquisition of an interest in national security land. FIRB Guidance Note 8 gives the example of a foreign-owned retail business not taken to acquire an interest in national security land by entering into a lease at Brisbane Airport's domestic terminal, notwithstanding that the Australian Federal Police occasionally undertakes intelligence functions there, so long as the retail lease area does not include areas where the Australian Federal Police operates.
National security land – land entities
- Under the FIRB regime, the acquisition by a foreign person of an interest in Australian land that, at the time of acquisition, is national security land triggers a FIRB approval requirement.
- FIRB Guidance Note 7 has been updated to clarify that the acquisition of securities in an Australian land entity will constitute the acquisition of an interest in national security land and trigger a mandatory FIRB approval requirement where the land entity holds any interest in national security land, even if the value of the entity's interest in national security land is less than half of the entity's total assets. This is subject to the various exemptions in the FIRB regime, including the acquisition of passive interests of not more than 5% in unlisted land entities and not more than 10% in listed land entities.
Land development conditions
- In what is a rather unwelcome development, FIRB Guidance Note 4 now provides that the land development conditions that usually apply to FIRB approvals for acquisitions of vacant commercial land will also apply to acquisitions of agricultural land and vacant commercial land for the purpose of operating a wind or solar farm. The Government says this is to ensure 'land banking' does not occur.
- The usual land development conditions will be that:
- a wind or solar farm must be developed on the land;
- continuous construction of the proposed development must commence within five years of completing the purchase of the land; and
- the land must not be sold, transferred, or otherwise disposed of prior to the development being completed (the 'no pre-completion sale condition').
- The no pre-completion sale condition is problematic as it is inconsistent with how wind and solar farm projects are usually financed and undertaken. Given the high development costs and lengthy timelines associated with such projects, it is common for interests in project land to be transferred prior to completion of construction, sometimes more than once.
- For instance, a common structure is for a developer (who may have limited ability to raise substantial project finance on its own) to acquire land for the purposes of a wind or solar project, and to sell all or part of the land to another developer during the development process so that the second developer can finance or contribute to development costs. The second developer (whether alone or together with the first developer) would then take the project to financial close and then sell all or part of the land at financial close or prior to completion of construction.
- This project structure would no longer be permitted by the new standard land development conditions. Given that many wind and solar farm projects in Australia have involved foreign investors, the Government's proposed conditions have the potential to significantly impact the commercial feasibility of such projects. If this results in fewer wind and solar projects than would otherwise be the case, this would not be in the national interest. These conditions also would have the perverse outcome that if a foreign developer proposed to sell the project to an Australian party prior to completion, it would effectively need to seek FIRB approval via waiver of the no pre-completion sale condition.
Agreements for lease
- FIRB Guidance Note 2 has been updated to provide that the entry by a prospective tenant into an agreement for lease (AFL) will in most cases constitute the acquisition of a leasehold interest in Australian land for FIRB purposes where:
- the AFL is unconditional and binding;
- a form of lease is attached to the AFL that includes key terms such as rent and term of the lease; and
- the lease itself is unconditional.
- This is a welcome development and reflects the approach already taken by many practitioners.
- It provides certainty for prospective landlords and tenants because a prospective tenant can seek FIRB approval (if required) prior to entering into an AFL (or make an AFL or lease conditional on seeking FIRB approval), and once FIRB approval is obtained there is no risk of the approval going 'stale' if the lease is not entered into within the approval validity period (normally 12 months). This is because, for FIRB purposes, the lease is already taken to have been entered into at the time of entry into an unconditional AFL.
Subdivisions and amalgamations
- The Government continues to take the view that a subdivision or amalgamation of land results in the landowner acquiring a new interest in Australian land, and therefore potentially triggering a new FIRB approval requirement.
- The legal basis and national interest concerns in relation to this are unclear, given that the landowner essentially owns the same land both pre and post subdivision or amalgamation. The Government's approach will result in foreign persons who own vacant commercial land or residential land, and FGIs who own any type of land, needing to seek FIRB approval for a subdivision or amalgamation.
- Some efforts have been made by the Government to seek to mitigate the adverse impacts on investors. FIRB Guidance Note 2 has been updated to provide that a deemed acquisition as a result of a subdivision or amalgamation is taken to have occurred for nil consideration, such that a $2,000 fee applies for seeking FIRB approval for each such acquisition. In addition, the updated Guidance Note makes clear that exemption certificates can cover such acquisitions.
Build-to-rent and other commercial residential premises
- The Government has a well-established policy that FIRB approval will generally not be granted for an acquisition by a foreign person of a freehold interest, or leasehold interest with freehold characteristics, in agricultural land that is being acquired for the purpose of undertaking a primary production business or residential development, unless the land interest was offered for sale through an open and transparent sale process.
- In what is a welcome development, FIRB Guidance Note 3 now provides that the Treasurer may consider waiving the open and transparent sale process for acquisitions of land for residential development where the residential premises are to be leased out by the applicant as part of a business (eg build-to-rent, retirement villages, aged care facilities and certain forms of student accommodation).
Change in trustee
- Under the FIRB regime, on a change of trustee of a trust, it is clear that where an incoming trustee is a foreign person, that person might need FIRB approval to acquire legal interests in trust assets. However, the FIRB legislation does not deal directly with the situation where an incoming trustee is not itself a foreign person but a foreign person has a 20% or greater interest in the trust, or two or more foreign persons together have a 40% or greater interest in the trust.
- There has been general consensus among practitioners that the assumption of trusteeship on a change of trustee is undertaken by the incoming trustee in its personal capacity, and therefore if the incoming trustee is not itself a foreign person, FIRB approval would not be required for the assumption of trusteeship. However, there has been a divergence of views among practitioners in relation to the steps needed to vest the trust assets in the incoming trustee. One view is that an incoming trustee acquires legal title to trust assets in a personal capacity to perfect its assumption of the trusteeship, rather than in its capacity as trustee – such that if the incoming trustee is not a foreign person then the FIRB rules cannot apply. An opposing and more conservative view is that the incoming trustee acquires legal title to trust assets in a trustee capacity, and therefore the foreign ownership of interests in the trust determines whether or not the incoming trustee is to be treated as a foreign person (even though there is no change to the beneficial interest held by the beneficiaries).
- The Government has opted for the conservative view in its updated FIRB Guidance Note 7, and consequently created a potentially significant issue for local funds managers and local professional trustee companies. Such persons who become trustees of trusts with foreign beneficiaries will now need to undertake their own analysis of whether FIRB approval is required, and where approval is required the exercise of identifying all trust assets that trigger a FIRB approval requirement may not be a straightforward one.
- The Government appears to have formed this view based solely on the definition of 'foreign person' in the FIRB legislation, which refers to a trustee of a trust. Updated FIRB Guidance Note 7 neither mentions, nor expresses, any view on, the fine distinctions between assuming and perfecting trusteeship on a change of trustee.
- The Government notes that the passive foreign custodian corporation exemption might apply, but this is not a complete solution given it would only apply where the incoming trustee acts as a custodian or bare trustee. In addition, this exemption does not extend to the reviewable national security action concept.
- The Government recognises, in the updated FIRB Guidance Note 7, that an incoming trustee that is considered a foreign person would only need FIRB approval if 'the relevant threshold is met'. However, no guidance has been given as to how to value a trustee's legal interest in trust assets for this purpose. Normally the full value of trust assets is attributed to the beneficial interest held by beneficiaries (such as unitholders in a unit trust). That said, an incoming trustee will be automatically subject to a nil dollar threshold to acquire interests in residential land, vacant commercial land, mining or production tenements and direct interests in national security businesses. A nil dollar threshold will also apply where the incoming trustee is considered an FGI by reason of beneficiaries being FGIs.
Retention licences and general purpose leases
- FIRB Guidance Note 5 now provides that the Government takes the view that a retention licence, general purpose lease or miscellaneous licence generally does not constitute an interest in Australian land because such a lease or licence ordinarily does not confer a right to occupy land.
- However, this will depend on the facts of each case. For instance, as specified in FIRB Guidance Note 5:
- If a general purpose licence entitles the licence holder to exclude others from using the licenced land (eg where the licence holder builds a road for private use only), that could constitute an interest in Australian land.
- Where a retention license or similar licence also provides the licensee a mining licence without further approval, that may require FIRB approval (it seems the Government considers such a licence to fall within the definition of 'mining or production tenement', rather than constituting an interest in Australian land).
- A retention licence that only confers a right to explore (including assessing economic feasibility) generally will not constitute an interest in Australian land.
Foreign government investors and associates
- Under the FIRB regime, FGIs (foreign government investors) from the same country are deemed to be associates of each other. This is significant because an FGI's 'interest' in an entity or business for FIRB purposes includes the interests of its associates, and this can impact on whether an FGI needs FIRB approval for a particular transaction.
- As many FGIs from the same country operate independently of each other, there can be situations where an FGI does not know that another FGI from the same country has, or intends to acquire, an interest in the same target.
- This issue was addressed in the pre-1 January 2021 FIRB guidance notes which provided that there are circumstances in which it would not be considered reasonable to expect an FGI to know that another FGI from the same country has, or intends to acquire, an interest in the same target (eg interest not publicly disclosed or otherwise known).
- This was removed from the 1 January 2021 FIRB guidance notes, but has now been reinstated in FIRB Guidance Note 2.
- This is welcomed, along with new guidance that:
- there are circumstances in which it would not be reasonable to expect an FGI to know that an entity or vehicle in which the FGI holds a substantial interest is acquiring, or has a direct interest in, an Australian entity or business (eg where the FGI is a passive investor in a collective investment vehicle); and
- there may be circumstances where it is not reasonable for an entity or a collective investment vehicle to know that FGIs have interests in the entity or vehicle which would make it an FGI (eg where there are legal restrictions that prevent them from knowing this).
- However, we query why the foregoing guidance only applies to FGIs and not also to foreign persons generally.
- Note that the effect of this guidance is that the Government has represented it would not enforce compliance through infringement notices, civil penalty proceedings or criminal prosecution in these circumstances. It does not create an exemption per se.
- FIRB Guidance Note 7 has been updated to provide that, in relation to the definition of 'Australian media business':
- the limb of the 'content test' regarding the delivery of content wholly or predominantly by way of programs of audio or video content is targeted at podcasts and TV streaming services (whereas the previous guidance was that these were merely examples); and
- when calculating the 10,000 person average daily audience for the purpose of the 'threshold test', regard should be had only to people in Australia.
- These updates are welcome, but there remains the residual concern that the content test is so broad as to cover businesses that do not provide content which would ordinarily be considered news or current affairs.
- It is generally understood that, under the FIRB regime, a convertible note can constitute an 'interest' in the underlying securities such that FIRB approval is required to acquire the convertible note. This has been confirmed in the updated FIRB Guidance Note 2. Note that imposing a FIRB condition precedent to the exercise of the conversion does not address the issue, because where FIRB approval is required it must be obtained before the convertible note itself can be acquired.
- The 1 January 2021 changes to the FIRB regime removed the exemption for acquisitions pursuant to a will, such that foreign persons who inherit Australian assets could be subject to a FIRB approval requirement.
- FIRB Guidance Note 2 has been updated to clarify that the point at which a foreign person is considered to have acquired an asset under a will is when the person acquires a legal interest on completion of administration of the will. The updated Guidance Note also provides that a foreign person can seek FIRB approval within 30 days after acquiring a legal interest, in circumstances where the person was not certain that they would acquire that interest. This is a welcome development.
- It has also been confirmed that the executor of a will generally does not need to seek FIRB approval to perform their executor duties, as the vesting of interests with the executor following a death are covered by the exemption of devolution by operation of law. However, as a matter of practice, an executor is often also appointed trustee as part of the will which opens up the issue of incoming trustees raised in FIRB Guidance Note 7. See our comments in Funds Management 'Change in trustee'.