On 7 May 2010 the Government released the Board of Taxation's Review of the Tax Arrangements Applying to Managed Investment Trusts (MITs) and its response to that Review. Significant changes have been proposed to the taxation of MITs that should reduce overall compliance costs and the tax burden of operating in the Australian environment.
The Board made 48 recommendations and the Government agreed to many of them. These follow on from recent reforms giving fund managers the ability to elect capital treatment on gains from realisation of certain assets and a reduction in withholding tax for foreign investors into qualifying Australian MITs.
This update reviews some of the more important recommendations.
Separate Taxation Regime for 'Regime MITs'
The Board considered that Division 6 of the Income Tax Assessment Act 1936, which deals with the taxation of trusts, created an unacceptable level of complexity and uncertainty when applied to MITs. It recommended that a separate taxation regime be developed for, what it termed, "Regime MITs". These are MITs that:
- are widely held – and in this regard the definition of an MIT in the withholding provisions in the Taxation Administration Act 1953 it believed would be a good starting point, subject to that definition being expanded to include specified wholesale trusts
- are engaged in primarily passive investment. This would essentially be defined by reference to the existing eligible investment business (EIB) definition in the public trading trust provisions (in Division 6C of the Income Tax Assessment Act 1936 (ITAA36)). This would therefore cover investment in real property to derive rental income and investing or trading in financial instruments, shares or units in unit trusts, and
- satisfied a "clearly defined rights" requirement which would necessitate that beneficiaries' right to income and capital be clearly established at all times in the trust's constitution and only able to be changed by a change to that document.
Regime MITs would be deemed to be "fixed trusts" for the purposes of a number of tax purposes such as the trust loss rules, simplified franking credit rules and CGT scrip-for-scrip rollover relief. This overcomes the uncertainty, at least so far as Regime MITs are concerned, which has persisted for some time in determining whether a trust could be treated as a "fixed trust".
The Government indicated agreement with these recommendations, other than the Board's proposal to redefine the EIB definition, and would consult on the implementation and design details.
The Board recommended that Regime MITs be able to make an irrevocable election to apply the attribution model as a means of determining tax liabilities for Regime MITs and their beneficiaries. The main features of this model are that:
- a beneficiary is assessable on the amount of taxable income of the trust that the trustee allocates to the beneficiary
- the allocation of taxable income between beneficiaries must be done on a fair and reasonable basis consistent with their rights under the trust's constitution, and
- taxable income that the trustee fails to allocate to beneficiaries within 3 months of the end of the financial year will be taxed in the trustee's hands at the highest marginal tax rate.
This recommendation, which was accepted by the Government, marks a significant departure from the longstanding basis of taxation of trust and beneficiaries which is determined by reference to the "present entitlement" of beneficiaries to a share of the income of the trust. As illustrated by the recent High Court decision in Bamford  HCA10, there has continued to be points of contention in the basis for assessment, which no doubt the Government will seek to address in legislation.
Streaming to be Addressed
The Government will develop specific integrity rules to address:
- instances of streaming of tax benefits or value shifting that could arise if changes are made to an MIT's constitution during the year, and
- the situation where the rights attaching to units in a Regime MIT are structured such that the taxable income of the trust is attributed to a tax exempt entity while other unitholders receive tax deferred or tax exempt distributions.
"Unders" and "Overs" to be Addressed
One issue which has been confronted by MITs has been in preparing, within the required timeframe, accurate end of year trust and taxable income calculations. It is often the case that, once more accurate information becomes available, it is evident that there has been an "under" or "over" reporting of the beneficiaries' net income from the MIT which necessitates later revisions. The Government proposes that all "unders" and "overs" below a de minimus level of either 5% of the net income of the Regime MIT for a year, or a prescribed dollar value per unit, be simply carried forward into the next income year. No penalty or interest would be payable in respect of "unders" and "overs" below this de minimus level. Where an "under" is greater than the de minimus specified, the trustee may determine to reissue distribution statements to beneficiaries within a certain timeframe. However, if no such statement is reissued, the trustee will be subject to tax on the full amount of the "under" at the highest marginal tax rate.
Double Taxation Issues
Double taxation issues can arise for beneficiaries of MITs where the taxable income of a MIT differs from the amount distributed, for example, if "tax deferred distributions" are received. The Board recommended that beneficiary-level cost base adjustments should continue (with modifications) for beneficiaries in Regime MITs. The Government agreed to this recommendation. However, a number of other recommendations made by the Board on this issue were either not agreed to by the Government or consideration of the issue was deferred.
Reform of public trading trust rules
Much hoped for reform of the public trading trust rules is largely left for another day. However, the Government will relax some aspects of these rules. In particular, it is proposed that a trust would not contravene these rules (and risk corporate taxation treatment being applied) simply because more than 20% of its units are held by complying superannuation funds and tax exempt entities entitled to a refund of franking credits.
As many of the changes will take effect shortly (many are proposed to take effect from July 2011), fund managers should now turn their mind to the likely impact of the changes on existing funds and factor this into the constitutions and product disclosure statements for new funds. Operational procedures will need to be reviewed in light of the proposed reforms.
This is only a summary of some of the more important recommendations covered in the Board of Taxation's Review of the Taxation of MITs. Please contact any of the partners listed on the right hand side should you have any questions concerning the Board's Review and/or the Government's response to it.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.