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Australia – What Is A Managed Investment Trust?

28 October, 2012

 

THE MIT REGIME – SNAPSHOT
 
WHAT IS THE MIT REGIME?
 
The Managed Investment Trust (MIT) regime is a concessional withholding tax regime that is used primarily by Australian REITs and managed funds. The key benefit of the MIT regime is that the rate of withholding tax on distributions of net rental income and capital gains made by an REIT may be as low as 15% in certain circumstances.
 
WHAT IS AN MIT?
 
 A ‘managed investment trust’ or MIT is a unit trust which satisfies certain requirements. These requirements are discussed in further detail at 2 below.
 
MIT WITHHOLDING TAX RATE 
 
The MIT withholding tax rate applies to distributions by MITs that are ‘fund payment’ amounts. The rate of withholding tax depends on the residence of the investor:
 
  • 15% for investors resident in EOI countries,
  • 30% in other cases.
 
The Australian Government announced in a media release on 27 June 2012 that a 10% withholding tax rate will apply to eligible distributions by MITs which hold only certain energyefficient buildings constructed from 1 July 2012. At the time of writing, the detail of this proposal remains unknown as draft legislation is yet to be introduced.
 
WHAT IS A ‘FUND PAYMENT’ AMOUNT?
 
In broad terms, a fund payment is a distribution of Australian source income (eg net rental income) including gross capital gains on taxable Australian property but excluding dividends, interest and royalties. Dividends, interest and royalties continue to be subject to the general withholding tax regime.
 
EOI COUNTRIES
 
 An EOI country is a country with which Australia has an ‘effective exchange of information’ agreement and which is listed in Regulation 44E of the Taxation Administration Regulations (Cth). There are currently 56 countries on the list. The EOI list includes most countries with which Australia has a tax treaty although this is not always the case, and there are countries on the list which do not have tax treaties with Australia. 
 
REQUIREMENTS FOR MIT STATUS 
 
The eligibility requirements for the MIT regime are discussed in further detail on the next page. In practice, the critical issues tend to be whether the following requirements are satisfied:
 
  • ownership requirement (the trust must satisfy a widely held ownership requirement and must also not be closely held under the applicable tests)
  • investment management requirement—a ‘substantial proportion’ of the ‘investment management activities’ must be carried out in Australia.
 
IF THE MIT REGIME IS NOT AVAILABLE?
 
If the MIT regime is not available, the non-resident investor will be required to include the trust distribution in their assessable income but may claim deductions for costs associated with the investment (eg interest on money borrowed to acquire an interest in the trust). The non-resident will be taxed at their relevant marginal rate upon lodgment of their tax return.

  

REQUIREMENT DESCRIPTION
REFERENCE TO 
DETAILED 
DISCUSSION IN THIS 
ARTICLE
CORPORATIONS 

 

ACT 
REQUIREMENTS
 
The trust must be a managed investment scheme (MIS) within the meaning of section 9 of the Corporations Act 2001 (Cth) (Corporations Act). Both registered and unregistered MISs can satisfy this requirement.
 
The requirements to be satisfied under the widely held and closely held tests will be dependent on whether the trust is a registered MIS (retail fund), whether it chooses to voluntarily register or whether it is unregistered (applicable to wholesale funds).
 
If the trust is a wholesale fund, then it must satisfy certain licensing requirements with respect to being operated or managed by the holder of an Australian Financial Services Licence (AFSL), or by an entity that is exempt from holding an AFSL.
 
Section 3
RESIDENCY 
REQUIREMENT 
The trustee of the trust must be an Australian resident or the ‘central management and control’ of the trust must be in Australia.
Section 4
TRADING TRUST 
REQUIREMENT
 
The trust must not be carrying on a ‘trading business’ or control another entity that is carrying on a ‘trading business’.
 
Section 5
INVESTMENT 
MANAGEMENT 
REQUIREMENT
 
A substantial proportion of the investment management activities carried out in relation to the trust in respect of the ‘Australian’ assets of the trust are carried out in Australia.
 
Section 6
WIDELY HELD 
OWNERSHIP 
REQUIREMENT
 
This requirement operates differently depending on whether the fund is a retail fund or a wholesale fund (registered or unregistered).
 
Section 7
CLOSELY HELD 
OWNERSHIP 
REQUIREMENT
 
As is the case with the widely held ownership requirement, this requirement operates differently depending whether the fund is a retail fund or wholesale 
fund.
 
Section 8

 

CORPORATIONS ACT REQUIREMENTS

  

Managed investment scheme
 
The trust must be a managed investment scheme (MIS) within the meaning of the Corporations Act 2001.
 
The Corporations Act defines an MIS by reference to the pooling of funds to generate financial benefits for people who do not have day-to-day control over the operations of the fund. We recommend that legal advice should always be sought as to the satisfaction of this requirement.
 
Does the MIS have to be registered for MIT purposes?
 
The provisions allow for registered and unregistered MISs to obtain MIT status. In certain circumstances, an unregistered MIS can become an MIT where the entity is a wholesale fund or operated by a Crown entity not subject to registration requirements under the Corporations Act. 
 
Broadly, retail funds are required to obtain MIS registration (although a wholesale fund can opt to voluntarily register). To obtain this registration, a registered MIS must have a Responsible Entity (RE) that operates the scheme. REs must be a registered Australian public company and hold an Australian Financial Services Licence (AFSL) that authorises the operation of a registered managed investment scheme.
 
Wholesale funds can choose whether to become registered or remain unregistered. In the instance that the fund remains unregistered, the trust must be operated by an AFSL holder or by an entity that is exempt from holding an AFSL. In this context, the AFSL must cover the provision of financial services to wholesale clients.
 
Classifying the entity as a registered or unregistered MIS is relevant for the purposes of determining the requirements 
that need to satisfied under the widely held and closely held tests (discussed in detail at 7 below).
 
Recent ASIC changes for REs
 
ASIC has recently introduced changes to the financial requirements for REs which are not regulated by APRA. Broadly, in order for REs to continue to hold an AFSL, the RE will be required to meet the following additional requirements:
 
  • provide 12-month rolling cash flow projections
  • satisfy the increased net tangible asset capital requirements, and
  • ensure that an increased amount of net tangible assets are held in cash.
 
The above requirements will commence on 1 November 2012 for all existing and new REs. Potential and current MITs should ensure that the RE, where relevant, implements the new requirements.
 
RESIDENCY REQUIREMENT
 
The trustee of the trust must be an Australian resident, or central management and control of the trust must be in Australia.
 
TRADING TRUST REQUIREMENT
 
If the trust is a unit trust, the trust must not be a trading trust. If the trust is not a unit trust, then it must not carry on a trading business or control another entity that is carrying on a trading business.
 
A trading trust is a trust that:
 
  • is carrying on a ‘trading business’, or
  • controls another entity that is carrying on a ‘trading business’.
 
A ‘trading business’ is any business that does not consist wholly of ‘eligible investment business’ activities. The legislation contains a list of specific activities that qualify as eligible business investment activities. Broadly, these are 
passive investment activities such as investing in land for the purpose, or primarily for the purpose, of deriving rent and investing or trading in shares, units or other financial instruments.
 
Example
 
AC Trust currently owns a property from which it derives rental income. In addition, the AC Trust also derives income from residential development activities which it undertakes. In this scenario, the development activities would not be considered an ‘eligible investment business’. The AC Trust would therefore be considered a trading trust and would not be eligible to obtain MIT status.

 

INVESTMENT MANAGEMENT REQUIREMENT
 
To satisfy this requirement, a ‘substantial proportion’ of the investment management activities carried out in relation to the trust in respect of all the following assets of the trust are to be carried out in Australia throughout the income year:
 
  • assets that are situated in Australia at any time in the income year
  • assets that are ‘taxable Australian property’ at any time in the income year, and
  • assets that are shares, units or interests listed for quotation in the official list of an approved stock exchange.
 
The focus of this requirement is on the investment decisions (and related activities) of the trust. Such decisions relate to the type of, and timing of the purchase of, investment assets.
 
Based on the limited guidance provided, the following activities will constitute investment management activities:
 
  • undertaking market analysis and identification of potential investment and opportunities
  • due diligence of potential acquisitions
  • providing recommendation on the asset mix of the trust (ie buy and sell recommendations), and
  • undertaking investment decisions (ie where to invest).
 
In determining whether such decisions are made in Australia or overseas, a substance-over-form basis for testing should be applied. This means that:
 
  • appointing an Australian investment manager which subcontracts its role to a non-resident manager will not be acceptable, and
  • appointing a non-resident manager that purports to make decisions in Australia on a fly-in, fly-out basis will also not be acceptable.
 
The local management test is applied on an annual basis having regard to the services provided in each year of income. Accordingly, if a non-resident entity is involved in the decision associated with the establishment of the trust, 
the trust may still become an MIT in subsequent years of income if the ongoing management of the fund is assumed by an entity in Australia.
 
Example – ATO guidance
 
Some private rulings discussing the investment management requirement have been issued. In one particular private ruling, the relevant investment management agreement provided that the trustee would provide, and be responsible for, 
the day to day management of the trust’s businesses, operations and properties and the investment management activities pertaining to the trust, including real estate investment and business management services.
 
The management agreement gave the trustee a very broad authority to conduct the significant majority of the investment and business management activities of the trust. However, the investment management agreement did ensure that the more significant aspects of the trust’s operations required unit holder approval.
 
This private ruling suggests that the Investment Manager needs to take a very active role in the management of the trust, but notes that the unit holder may approve decisions the trustee has already made (ie approve decisions already made rather than the unit holder making the decisions on behalf of the trustee). 

 

WIDELY HELD OWNERSHIP REQUIREMENT
 
The widely held requirement is dependent on the type of fund and whether it is a registered or unregistered MIS. Specifically:
 
  • if the trust is a retail fund, then it must be listed, or have at least 50 members or satisfy the 25/60 test (see 7.3 below for details)
  • if the trust is a registered wholesale fund (ie it has chosen to voluntarily register as an MIS), then it must have at least 25 members or satisfy the 25/60 test, or
  • if the trust is an unregistered wholesale fund (ie it is not a registered MIS) it must have at least 25 members.
 
The tests involve counting the number of ‘members’ of the MIT and sometimes counting the size of the interest in the MIT that investors hold, directly or indirectly (known as MIT participation interests). In certain circumstances concessions are available (for example if the entity is a qualifying investor) to increase the number of deemed members.
 
In determining the number of members for the purposes of the widely held and closely held requirements, it is important to firstly understand the concept of a qualifying investor.
 
Qualifying investor
 
The categories of qualifying investor include:
 
  • complying superannuation funds, complying approved deposit funds and foreign superannuation funds with at least 50 members
  • pooled superannuation funds with at least one complying superannuation fund member
  • Australian life insurance companies
  • another MIT
  • certain foreign collective investment vehicles (CIVs)
  • certain foreign pension funds and sovereign wealth funds, and
  • certain government agencies.
 
A complete list of qualifying investors is attached at Attachment 3.
 
Determining the number of members
 
As a starting point in determining the number of actual or deemed members, each investor is counted as one member regardless of the percentage they hold in the trust. For example, in the scenario that Trust A is owned in equally by three Australian companies, Trust A has three members.
 
However, the widely held requirement may, on a concessional basis, ‘deem’ members to exist for the purposes of applying the widely held tests. The widely held ownership tests apply on a concessional basis where a fund has investors that are qualifying investors. In calculating the number of members, a qualifying investor is deemed to be more than one member based on the following formula:
 
No of members = qualifying investor’s MIT participation interest (%) multiplied by 50
 
So, for example, if a foreign pension fund (a qualifying investor) owns 50% of an MIT, the portion owned by that fund would be taken to represent 25 members (where the formula provides that the number of numbers is determined by 
multiplying the MIT participation interest (50%) by 50).
 
Broadly, the rationale is that qualifying investors are themselves sufficiently widely held so as to warrant a relaxation of the widely held ownership test that would otherwise apply. 
 
25/60 test
 
The 25/60 test is an alternative test to the number of members test and is available for registered funds (including voluntarily registered funds), whether retail or wholesale.
 
The 25/60 test is satisfied if:
 
  • a qualifying investor(s) holds an MIT participation interest of 25% or more, and
  • there is no single non-qualifying investor that holds an MIT participation interest of 60% or more.
 
Tracing through interposed entities
 
For the purposes of both the widely held and closely held requirements, tracing through interposed trusts is allowable for determining MIT participation interests of investors. However, the provisions do not allow for tracing through other entities.
 
Example
 
Trust A is ultimately owned by a qualifying investor and a non-resident limited partnership. The qualifying entity owns its 75% stake through a corporate entity. For the purposes of the member test and the 25/60 test, the 75% interest is taken to be held by the corporate entity and not the qualifying entity. Therefore, the trust will be taken to have only two members (being the limited partnership and the corporate entity).
 
CLOSELY HELD OWNERSHIP REQUIREMENT
 
Similar to the widely held test, the closely held requirement is dependent on the type of fund:
 
  • if the trust is a retail fund, it must not be the case that 20 or fewer persons (excluding qualifying investors) have a 75% or more MIT participation interest and there must be no foreign resident individual with a 10% or more MIT participation interest, or
  • if the trust is a wholesale fund (whether registered or unregistered), it must not be the case that 10 or fewer persons (excluding qualifying investors) have a 75% or more MIT participation interest and there must be no foreign resident individual (ie human) with a 10% or more MIT participation interest.
 
In determining the MIT participation interest of the foreign resident individual, it appears that it is necessary to trace through all types of entities. For example, a foreign resident individual that holds a 15% interest in a trust via a wholly 
owned company would be taken to have a greater than 10% interest for this purpose.
 
Example – unregistered wholesale fund
 
  • Aus Trust is a unregistered wholesale fund.
  • Hedge Fund 1 and Hedge Fund 2 are offshore limited partnerships with numerous partners that are not qualifying 
  • investors.
  • Foreign Pension Fund is a foreign superannuation / pension fund with at least 50 members.

Please click here for a diagram (page 11 of the pdf).
 
Widely held requirement
 
Prima facie, Aus Trust would have three members, Hedge Fund 1, Hedge Fund 2 and Foreign Super Fund. However, because Foreign Super Fund is a qualifying investor, it will be counted as the following number of members:
 
No of members  =  60% (MIT participation interest) x 50
=  30
 
Aus Trust will satisfy the 25 member test-Hedge Fund 1 and Hedge Fund 2 will be counted as 2 members (there is no ability to trace through a limited partnership and so it counts as one member). Foreign Super Fund is a qualifying investor and will be taken to be 30 members. Therefore, Aus Trust will be taken to have 32 members and satisfies the member test.The 25/60 test will not be available to Aus Trust as it is an unregistered MIS.
 
Closely held requirement
 
The closely held requirement will not preclude the trust from obtaining MIT status in this scenario. Specifically:
 
  • Hedge Fund 1 and Hedge Fund 2 do not hold greater than 75% interest in Aus Trust, and
  • no single foreign resident individual has an interest in the trust of 10% or more

 

ATTACHMENT 1
 
Summary of key requirements

 

  Options for meeting the widely held requirement      
 
Listing Test
Number of 
Members Test
25/60 test
Closely held 
Exclusion
Retail Limitation
Licensing
 
Compulsorily Registered Scheme
Yes
50 or more ‘Qualifying’ investors can count as several members
‘Qualifying’ 
investor(s) has 25% or more and no non-‘qualifying’
investor has 60%
20 or fewer non 
‘qualifying’ 
investors have 75% or more
or 1 foreign 
individual has 10% or more
N/A
Corporations Act requirements
Voluntarily Registered 
Wholesale Scheme
No
25 or more
‘Qualifying’ investors can count as several members Retail investors 
are not counted
‘Qualifying’ 
investor(s) has 
25% or more and 
no non-
‘qualifying’ 
investor has 60%
10 or fewer non 
‘qualifying’ 
investors have 
75% or more
or
1 foreign 
individual has 
10% or more
20 or more retail 
investors
or Retail investors 
hold more than 
10%
Operated or 
managed by 
wholesale AFS 
licensee or certain Crown or 
ASIC-excluded 
entities
Unregistered Scheme
No
25 or more
‘Qualifying’ 
investors can 
count as several 
members
Retail investors 
are not counted
No
10 or fewer non 
‘qualifying’ 
investors have 
75% or more
or
1 foreign 
individual has 
10% or more
20 or more retail 
investors
or
Retail investors 
hold more than 
10%
Operated or 
managed by 
wholesale AFS
licensee or 
certain Crown or 
ASIC-excluded 
entities

 

ATTACHMENT 2

 
Current EOI countries
 
The current EOI countries are detailed in the table below:

 

EOI COUNTRIES
Argentina; Netherlands ; Antilles; Jersey
Bermuda; New ; Zealand; Gibraltar
Canada; Norway ; Guernsey
China ; Papua New Guinea; Belize
Czech ; Republic; Poland; Cayman Islands
Denmark; Romania ; The Commonwealth of the Bahamas
Fiji ; Russia ; Principality of Monaco
Finland; Slovakia; The Republic of San Marino
France; South Africa; The Republic of  Singapore
Germany; Spain; Saint Kitts and Nevis
Hungary; Sri Lanka; Saint ; Vincent and the Grenadines
India;  ; Sweden ; Anguilla
Indonesia; Taipei ; Aruba
Ireland; Thailand; Belgium
Italy; United ; Kingdom; Malaysia
Japan ; United States of America; Turks and Caicos Islands
Kiribati ; Vietnam; Cook Islands
Malta; Antigua and Barbuda; Macao
Mexico ; British Virgin Islands; Mauritius
Netherlands ; Isle of Man; Republic of Korea

 

Pending EOI countries
 
The following countries have entered into information exchange agreements with Australia but have not yet achieved status as an EOI country.
 
Bahrain; Dominica; Grenada
Liberia; Lichtenstein; Marshall Islands
Montserrat; Samoa; St Lucia
Vanuatu; Costa Rica
 
ATTACHMENT 3
 
Definition of qualifying investor 
 
The categories of qualifying investor include:
 
  1. complying superannuation funds, complying approved deposit funds and foreign superannuation fund with at least 50 members
  2. pooled superannuation funds with at least one complying superannuation fund member that has at least 50 members
  3. Australian life insurance companies
  4. another MIT
  5. an entity that:
    1. is recognised under a foreign law as being used for collective investment by means of pooling the contributions of its members as consideration to acquire rights to benefits produced by the entity, and
    2. that has at least 50 members, and
    3. the contributing members of which do not have day-to-day control over the entity’s operation.
  6. an entity, the principal purpose of which is to fund pensions (including disability and similar benefits) for the citizens or other contribution of a foreign country, if:
    1. the entity is a fund established by an exempt foreign government agency, or
    2. the entity is established under a foreign law for an exempt foreign government agency, or
    3. the entity is a wholly-owned subsidiary of either (a) or (b) above.
  7. an investment entity that satisfied all of these requirements:
    1. the entity is wholly owned by or is a subsidiary of one or more foreign government agencies
    2. the entity is established using only the public money or public property of the foreign government concerned
    3. all economic benefits obtained by the entity have passed, or are expected ot pass, to the foreign government concerned, and
    4. an entity established and wholly-owned by an Australian government agency, if the capital of the entity, and returns from the investment of that capital, are used for the primary purposes of meeting statutory government liabilities or obligations (such as superannuation liabilities and liabilities arising from compensation or Workcover claims).

ATTACHMENT 4
 
Recent MIT decisions made by the Australian Taxation Office The Australian Taxation Office (ATO) has released guidance materials outlining its view in respect of specific MIT related issues. We note that the ATO’s view as summarised in the below table may or may not be binding on the Commissioner and can only be relied upon in limited circumstances if any.
 
REFERENCE
OVERVIEW
 
ATO ID 2010/32
 
In this particular decision, the ATO determined that 1,000 limited partners of a German KG (which is treated as a limited partnership for German and Australian tax law purposes) were not to be considered 
‘members’ of the trust for the purposes of determining whether the number of members test within the MIT widely held requirement had been satisfied.
Specifically, the limited partners were determined to not have the interest or rights that give rise to being a unitholder in the Australian trust.
 
ATO ID 2010/143
 
A United States (US) Real Estate Investment Trust (REIT) was determined to be a qualifying investor for the purposes of the MIT widely held requirement. In making its determination, the ATO relied heavily 
on the MD corporate code (the law under which the US REIT was formed) in determining whether each of the following qualifying investor criteria was satisfied:
 
• the US REIT was recognised under a foreign law as being used for collective investment
• the REIT was pooling contributions of at least 50 members of the entity as consideration to acquire rights to the benefits produced by the entity, and
• members of the entity did not have day-to-day control over the operation of the entity.
 
ATO ID 2011/4 
 
An Irish Investment Limited Partnership (Irish ILP) was determined to be a qualifying investor. Similar to the approach in ATO ID 2010/143 outlined above, the ATO relied on Ireland’s Investment Limited Partnership Act under which the partnership was formed to determine whether the Irish ILP was a qualifying investor. The criteria to be satisfied were the same as outlined in ATO ID 2010/143.
 
PRIVATE RULINGS 
1011544672063
AND
1011543866023
 
These private rulings consider (issued in October 2010) the concept of substantial investment management activities being carried on in Australia.
 
In the scenario that is subject of the ruling, a unitholder in a trust (ie the potential MIT) had entered into a management agreement with the trustee which provided a broad mandate in relation to the day-today management of the trust’s business and operations and also sourcing new investments, making recommendations, reporting, negotiating contracts and risk policy development and enforcement. The management agreement also required that the trustee seek the unitholder’s approval.
 
The ATO concluded that this arrangement will satisfy the requirement as even though the unitholder could choose to not approve the trustee’s decisions, the trustee has undertaken substantial activities in Australia.
 
PRIVATE RULING 
1012119087422
 
In this private binding ruling (issued in May 2012), the ATO determined that the investment management activities requirement was not satisfied.
 
The ATO considered that the following factors may be relevant in determining if a substantial proportion of investment management activities is carried out in Australia (having regard to the pattern of activities in the particular circumstances of that case):
 
• the extent to which the investment manager has ‘control over the assets of the trust’, where ‘control’ means the ‘authority to decide and direct and not merely to participate in decisionmaking’ over investments of the relevant trust
• the extent to which the investment and subsequent dealings in the trust’s asset(s) is made under a specific pre-formulated investment mandate which pre-dates any actual decision or activity to be 
conducted by the investment manager 
• the extent to which any such specific pre-formulated investment mandate was made by an entity(s) resident outside of Australia
• the extent to which the ‘investment management activities’ are ‘substantial’ or ‘material’ (e.g. the maintenance of proper books of accounts in relation to the trust’s assets would of itself be unlikely to constitute a ‘substantial proportion of investment management activities’), and
• whether the activities are ‘investment management activities’ involving decisions relating to ‘the type of and timing of the purchase of investment assets’ as opposed to activities relating to the 
‘operation and management’ of the trust such as the provision of custodial services, servicing the underlying assets of the trust and provision of professional services in relation to acquisitions or 
disposals of assets of the trust.
 
PRIVATE RULING 
1011493321942
 
This private ruling (issued in August 2010) considers whether the trustee of an MIT had by its power of veto the ability to ‘control the affairs or operations’ of a trading company (OpCo) such that the MIT 
would breach the ‘trading trust’ requirements.
 
In the scenario that is the subject of the ruling, the trustee of the MIT had a power of veto over certain ‘Shareholder Matters’ of OpCo which the ATO considered ‘pertained to OpCo’s structure, future direction and ongoing corporate governance and management’.
 
In particular, the MIT trustee had the ability (through its veto power) to ‘block a resolution put to shareholders by the Board of Directors’ in relation to the Shareholder Matters.
 
The ATO considered that ‘control’ for the purposes of the ‘trading trust’ requirements includes the concept of ‘negative control’ such that the ability to block decisions in relation to the ‘structure, scope and management’ of OpCo’s business and ‘effectively usurp the discretion of the Board of Directors’ in relation to those matters resulted in the MIT breaching the trading trust requirement.
 
 

  

For further information, please contact:

 

David Sinn, Partner, Herbert Smith Freehills 

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