15 April 2015
Australia Tax Alert
By Betsy-Ann Howe, Elizabeth Gray
On 9 April 2015, the Federal Government released exposure draft legislation to introduce a proposed new tax system for eligible managed investment trusts. The changes contained in the draft legislation largely follow recommendations the Board of Taxation made in its Report on the Review of Tax Arrangements Applying to Managed Investment
Trusts in August 2009 (the Board's Report).
The managed funds industry and other key stakeholders were consulted during the development of the new tax system for managed investment trusts (MITs).
Broadly, the changes introduce a new taxing system for trusts which fall within a new broadened definition of MIT and whose members have 'clearly defined interests' in relation to the income and capital of the trust. Trusts which satisfy these requirements will be referred to as attribution MITs (A-MITs) and will be subject to a new tax regime.
Key features of the new A-MIT tax system
attribution model for determining member tax liabilities
, which allows amounts to retain their tax character as they flow through an A-MIT to its members the
ability to carry forward understatements and overstatements of taxable income
, instead of re-issuing investor statements
deemed fixed trust treatment
under the income tax law upwards
cost base adjustments to address double taxation
certainty about the treatment of tax deferred distributions
Before considering the proposed rules which will apply to A-MITs, the proposed change to the existing definition of MIT should be noted. The draft legislation proposes to extend the definition of MIT and as a result eligibility for certain tax concessions would be extended. These include:
• concessional withholding tax rates for non-resident members of MITs (15% for residents in EOI countries, otherwise 30%)
• eligibility to elect to apply the capital gains tax (CGT) provisions to gains and losses made on the disposal of certain assets held as passive investments.
Under the current rules, a trust is a MIT if, broadly:
• the trustee of the trust is an Australian resident or the central management and control of the trust is in Australia the trust carries out most of its investment management activities in relation to
Australian assets in Australia the trust does not carry on or control an active trading business
• the trust is a managed investment scheme (within the meaning of the
Corporations Act 2001 (Cth)
• the trust is sufficiently 'widely-held' and not 'closely-held' the trust is operated or managed by an appropriately regulated entity.
The draft legislation proposes to modify the definition of an MIT as follows:
• extend the start-up period during which trusts do not need to meet the widelyheld and not closely-held requirements to qualify as a MIT
• modify the widely-held requirements to extend the list of eligible investors in a
Irrespective of whether a trust falls within the definition of an A-MIT, the extended definition of MIT will be relevant to trusts which may qualify as MITs once the new definition of MIT is legislated and can therefore access MIT withholding and CGT concessions.
Under the proposed new A-MIT tax system, a trust will qualify as an A-MIT if, generally:
• the trust is a MIT
• its members have 'clearly defined interests'.
The 'clearly defined interests' criterion will require that members of a trust have clearly defined interests in the income and capital of the trust. Two different tests will apply in determining whether the members of a trust have clearly defined interest, depending on whether or not the trust is a managed investment scheme under the
or not. Both tests look at constituent documents of the trust and, specifically, rights as between members and as between trustees and members. The stated objective of the 'clearly defined interests' requirement is to ensure that:
• there is an objective benchmark for the attribution of tax consequences of the activities of the trust to its members
• only trusts which are sufficiently non-discretionary receive the benefits available to A-MITs eg deemed fixed trust treatment.
In addition, the draft legislation proposes that for the purposes of working out whether an
MIT qualifies as an A-MIT, debt-like instruments issued by the trust will be treated as debt interests rather than as membership interests.
If a trust is an A-MIT, a new tax regime will apply to it. The key features of the proposed new regime are summarised as follows.
: for income tax purposes, A-MITs will be able to attribute amounts of taxable income, exempt income, non-assessable non-exempt
• income, tax offsets and credits to members on a fair and reasonable basis in accordance with their clearly defined interests in the A-MIT. A key consequence of this is that an attribution model will apply to the A-MIT instead of the general trust provisions in the income tax law in Division 6 of the
Assessment Act 1936 (Cth
). Further special rules will be introduced to ensure that the PAYG withholding provisions and withholding tax liability provisions apply appropriately to A-MITs and their members, including members that are custodians.
Attribution for multiple classes of members
: if the interests in the income and capital of an A-MIT are divided into classes, under the draft rules such an A-MIT will be able to apply the attribution regime separately to each class of interests if certain requirements are met and an irrevocable election is made. If the choice is made, each class will effectively be treated as a separate trust with separate trust property. This is likely to have a number of important outcomes for the funds management industry.
Character flow through
: a character flow through model will apply under the new rules to ensure that amounts derived or received by an A-MIT, that are attributed to members, retain the character they had in the hands of the trustee for income tax purposes. This overcomes uncertainty and complexity in respect of certain types of amounts distributed to beneficiaries of trusts.
Cost base adjustments and certainty regarding tax deferred distributions
: the proposed rules aim to eliminate double taxation that might otherwise arise by way of allowing members of A-MITs to make annual upward and downward adjustments to the cost bases of their interests in an A-MIT. In addition, the taxation treatment of tax deferred distributions made by an A-MIT will be clarified, so that such distributions are treated as resulting in a downward adjustment in the cost base of member interest and not otherwise being assessable. As a result, uncertainty which arose following certain Australian
Taxation Office (ATO) pronouncements (eg ATO ID 2011/58 ) will be overcome for members of A-MITs.
: Trustees of A-MITs will be liable to pay tax in some circumstances under the A-MIT attribution regime. These include circumstances where liability would normally arise under the current rules, for example, trustee liability to net income to which no beneficiary is presently entitled. However, it is proposed that trustee liability will also arise in other novel circumstances, for example, the trustee of an A-MIT will be liable to pay income tax on non-arm's length income derived by an A-MIT.
Debt-like A-MIT instruments
: Debt-like instruments issued by a trust will be treated as debt interests rather than as membership interests for the purposes of determining whether a trust is an A-MIT. In addition, it is proposed that: o
the attribution regime will not apply to the holders of debt-like A-MIT instruments o
an A-MIT will be able to deduct returns on debt-like A-MIT instruments in certain circumstances and the interest withholding tax provisions would apply to such returns when paid to non-residents o
debt-like A-MIT instruments will be treated as debt for the purposes of applying other provisions in the income tax law, such as the thin capitalisation rules.
Rules which classify instruments as debt-like for A-MIT purposes do not rely on the existing debt-equity rules contained in the
Income Tax Assessment Act 1997
, which generally apply interests in corporate entities. Rather, a test specific to the A-MIT rules will be introduced which considers, among other things, whether the distribution relating to an interest is fixed and the priority of the interest holder in the event of insolvency.
Treatment of 'unders and overs'
: if a trust discovers a variance between the amounts actually attributed to members for an income year, and the amounts that should have been attributed, the trust will be able to reconcile the variance in the income year that it is discovered by using the ‘unders and overs’ regime.
This approach accords with industry practice and addresses industry concerns that trustees would be required to reissue distribution statements to beneficiaries and, consequently, beneficiaries needing to seek amendments to their income tax returns.
Deemed fixed trust treatment
: A-MITs will be deemed to be fixed trusts for the purposes of the income tax law. Classification as a fixed trust is relevant for a number of regimes under the income tax law, including tests applying to franking credits and the utilisation of tax losses by trusts.
According to the explanatory material accompanying the draft legislation, trustees of existing MITs will need to embark on due diligence activities to determine whether changes are required to be made to trust deeds, other constituent documents, product disclosures and other investor material in order to apply the new A-MIT tax system.
Further, the explanatory material acknowledges that concerns have been raised that tax consequences may arise if the constituent documents of a trust are changed in order to apply the new A-MIT tax system. Such changes may give rise to the resettlement of a trust, with attendant tax and stamp duty consequences. The explanatory material notes that the ATO has issued a Taxation Determination stating that if the terms of a trust are changed, pursuant to a valid exercise of a power contained in the trust’s constituent documents, no capital gains tax consequences arise as a result of the change ( Taxation
Determination TD 2012/21 ). It is hoped a similar result will apply to changes required to trust deeds to bring existing trusts into the A-MIT system.
Notwithstanding the above, from a corporate law perspective, regulatory hurdles to changing registered managed investment scheme constitutions in order to apply the new tax system for A-MITs will need to be addressed at some point.
According to the draft legislation, the new A-MIT system will broadly apply to income years starting on or after 1 July 2015 (the deferred start date as announced in the
2014/15 Federal Budget). However, certain aspects of the proposed legislation will not apply until later income years, for example, trustee liability to non-arm's length income derived by a A-MIT is stated to not apply until 1 July 2017.
While the draft legislation is still subject to consultation before it is introduced to the parliament and enacted into law, it would nevertheless be prudent to consider how the rules may apply to trusts generally and existing MITs in particular.
If you would like further information on these changes, please contact Betsy-Ann Howe or Elizabeth Gray.
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