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Australia – New Tax Regime For Certain MITs.

22 April, 2015

 

Legal News & Analysis – Asia Pacific – Australia – Tax

 

Exposure draft legislation and explanatory material released


What You Need To Know

 

  • The Government has released exposure draft legislation and explanatory material for the new tax regime to apply to managed investment trusts (MITs) in which members have “clearly defined rights”. The regime is scheduled to apply from 1 July 2015.
  • Trusts that do not qualify to apply the new regime will continue to be taxed under the current trust tax provisions (ie on a present entitlement basis).
  • The qualifying requirements to be an MIT will be expanded by increasing the start-up period and extending the list of eligible investors.
  • Division 6B will be repealed.
  • The 20% tracing rule in Division 6C will be amended to remove complying superannuation funds and tax exempt entities that are entitled to a refund of franking credits.

 

What You Need To Do

 

  • Consider whether you wish to make a submission on the exposure draft material. Submissions are due by 23 April 2015. Submissions can be made here.
  • Revisit existing trusts that have not previously qualified as MITs to determine if they now will.
  • Review your constituent documents to determine whether amendments are needed for the new tax regime to apply.
  • Review systems to determine if changes are required once the new system applies.
  • Consider whether the amendments allow scope for new products or structures to be developed.
  • Monitor changes to the draft legislation, particularly in relation to the timing for the application of the proposed changes and any elections that might be available.

Overview


The Government released exposure draft legislation and explanatory material to introduce a new tax regime for certain MITs on 9 April 2015. Such a regime was first proposed in 2010.


The new regime will:

 

  • expand the circumstances in which a trust will be a “managed investment trust” (for all purposes);
  • introduce an attribution regime for the taxation of “attribution MITs” (AMITs);
  • allow for character flow through of amounts to members of AMITs;
  • treat AMITs as fixed trusts (removing the previous uncertainty created by Colonial First State Investments Ltd v FCT [2011] FCA 16);
  • allow for “unders and overs” to be dealt with in the year in which they are discovered, with a gross up to reflect the shortfall interest charge if they are significant; and
  • include some integrity measures, including a new non-arm’s length income rule.

 

If the new provisions apply, the current tax rules for trusts (in Division 6) will no longer apply. The flow through rules for franked dividends (Subdivision 207-B) and capital gains (Subdivision 115-C) will also not apply.


The legislation will also:

 

  • repeal Division 6B; and
  • amend Division 6C to exclude complying superannuation funds and certain exempt entities from the 20% tracing rule.

The draft legislation proposes that the amendments will apply from 1 July 2015, other than the expanded definition of managed investment trust, which will apply from 1 July 2014.

 

Submissions on the exposure draft material are due by 23 April 2015.


Expanded Definition Of Managed Investment Trust


A trust will qualify for MIT treatment in a broader range of circumstances if the legislation is enacted. This change will be relevant to the new tax regime for AMITs, as well as existing MIT provisions such as the deemed capital account treatment rules and the MIT withholding rules.


The most significant change is the expansion of the list of eligible investors into an MIT to include:

 

  • foreign life insurance companies regulated under foreign law; and
  • wholly owned subsidiaries of one or more other eligible investors.

These changes will apply from 1 July 2014.


The Attribution Model For AMITs


Eligiblity


A trust will be eligible to apply the new taxation regime if it is an AMIT. This requires that:

 

  • the trust is a MIT; and
  • the members of the MIT have clearly defined interests.

The clearly defined interests test varies depending on whether or not the MIT is registered under the Corporations Act 2001. However, generally it requires that amounts can be attributed to members on a fair and reasonable basis in accordance with the constituent documents, and that the rights of members to capital and income cannot be materially diminished through the exercise of a power or right.

 
The scope of the requirement that rights to capital and income cannot be materially diminished is unclear, and could be difficult to satisfy if, for example, it encompasses a power to reclassify receipts as income or capital (as is common in most trust deeds).

 
Changes To Constituent Documents

 
Many MITs will need to amend their constituent documents in order to be eligible to apply the new regime. Trustees will need to consider whether any required amendments will have tax consequences (eg, give rise to a resettlement) – although the explanatory material suggests that there should generally not be tax consequences where changes are made pursuant to an existing power of amendment.


MITs that are registered schemes will need to comply with Corporations Act requirements for any amendment to their constitutions and, in the absence of ASIC relief or further legislative provision, the amendments are likely to require a special resolution of members of the scheme.


All MITs will need to consider whether the amendments will require approval by or notification to other interested parties. For example, an MIT security holder may require approval of its own investors or its secured lenders to vote in favour of an amendment.
There may be particular complications in the amendments required to satisfy the requirement that the members of the MIT have “clearly defined interests” where the MIT is part of a stapled group and there are intra-group adjustment discretions.


Principles Of Attribution


Under the new regime, the trustee of an AMIT will determine the character of amounts of income and tax offsets. There are four basic characters:

 

  • income (eg capital gains, amounts subject to withholding tax, ordinary or statutory income from a foreign or domestic source);
  • exempt income;
  • non-assessable non-exempt income; and
  • tax offsets (eg franking credits, foreign income tax paid).

These amounts will be attributed to the members (net of allowable deductions allocated on a reasonable basis) and will retain their character in the hands of the members.

 
The amounts and components will be set out in an AMIT Annual Member Statement (or “AMMA Statement“) which the AMIT must give to each entity that was a member of the AMIT at any time in the income year. The AMMA Statement must be given within 3 months after the end of the income year.

 
Members will also be able to make upwards and downwards adjustments to the cost base of their interests in AMITs to reflect non-assessable distributions, tax deferred distributions (if held on revenue account, the tax cost will be reduced) and the sale of an interest prior to receiving a distribution. The new regime clarifies that tax deferred distributions are not assessable as ordinary income (whether the interest in the AMIT is held on capital or revenue account).

 
Unders And Overs

 
Under the new regime, trusts will be able to use an “unders and overs system” to adjust for a variance in a type of income or offset in the year in which the “under or over” is discovered. Alternatively, the MIT could choose to adjust for the variance in the income year to which it relates by recalculating the amounts attributed to members for that year (which would then require the members to amend their tax returns for the prior year).

 
If there is a variance that is substantial (measured objectively against the trust’s income and offsets or net assets) and the unders and overs system is applied, the MIT will be required to uplift the variance based on the shortfall interest charge to account for the time value of money.

 
Trustee Liability

 
The trustee of an AMIT may still be liable to pay tax at the top marginal rate (plus applicable levies) in certain circumstances, including:

 

  • if particular amounts are incorrectly or not fully attributed to members;
  • if unders of an income character or overs of an offset character are not carried forward properly;
  • if the AMIT receives non-arm’s length income (which will occur if, under a scheme where the parties were not dealing with each other at arm’s length and one of the them is not an AMIT, the AMIT receives an amount greater than would have been expected if the parties were dealing at arm’s length).

 
A limited transitional rule has been proposed for nonarm’s length schemes entered into prior to the Bill proposing the new regime being introduced to the House of Representatives. If the transitional rule applies, non-arm’s length income will not be taxed as such before 1 July 2017, allowing time for such schemes to be changed.

 
As is generally the case under the current rules, the trustee may also be liable for tax in relation to certain taxable amounts attributed to a non-resident member. The rate of tax will depend on the nature of the member.

 
Withholding Tax Rules For AMITs

 
The proposed legislation will modify the withholding rules for dividends, interest, royalties and fund payments to ensure that AMITs are required to withhold from both actual and deemed payments (reflecting amounts attributed to members as set out in their AMMA Statements) to non-resident members, with appropriate adjustments to ensure that there is no double withholding on amounts that are both attributed and paid to members.

 
Special withholding rules will apply to amounts paid or attributed to custodian members holding units in the trust for foreign residents.

 
Amendments To Division 6C 20% Tracing Rule

 
Division 6C will be amended to exclude superannuation funds and exempt entities that are entitled to a refund of imputation credits in applying the 20% tracing rule that could result in a trust being a public unit trust for the purposes of this Division. This is consistent with the Board of Taxation’s recommendations in August 2009.

 
Division 6C applies to tax “public trading trusts” as if they were companies. In order to be a public trading trust, a trust must first be a “public unit trust”. Broadly, this criterion can currently be met if “exempt entities” (which includes complying superannuation funds) hold 20% or more of the beneficial interests in the trust. If a trust is a public unit trust and carries on business other than “eligible investment business”, the Division could apply to tax the trust as a company rather than on a flow through basis under Division 6.

 
This provision has been particularly difficult for superannuation funds to navigate and can make it unattractive for superannuation funds to invest in trusts which have non-passive investments, making this change very welcome.

 
Repeal Of Division 6B

 
In accordance with the Board of Taxation’s recommendation and previous government announcements, Division 6B will be abolished. Division 6B broadly applies to tax “corporate unit trusts” as if they were companies. The provisions are aimed at preventing the reorganisation of companies by transferring assets or businesses to public unit trusts in order to attract trust tax treatment.

 

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For further information, please contact:

 

Ian Kellock, Partner, Ashurst
ian.kellock@ashurst.com

 
Paul O’Donnell, Partner, Ashurst
paul.o’donnell@ashurst.com


Michael Ryland, Partner, Ashurst
michael.ryland@ashurst.com


Ian Fullerton, Ashurst
ian.fullerton@ashurst.com


Bronwyn Kirkwood, Ashurst
bronwyn.kirkwood@ashurst.com


Marcus Ryan, Ashurst
marcus.ryan@ashurst.com


Sanjay Wavde, Ashurst
sanjay.wavde@ashurst.com

 

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