Australia: Managed Investment Trust Reforms Now Law

We have previously reported on the various proposals concerning reform of the tax treatment of Managed Investment Trusts (MIT). The two main tax reforms relate to:

  • allowing MITs to make an election to treat gains and losses on the disposal of certain assets as being subject to capital gains tax (CGT) treatment, thereby allowing certain investors in the MIT to enjoy a CGT discount on gains on underlying investments, and
  • extending the definition of an MIT so that a greater range of funds may take advantage of the 7.5% withholding tax rate that applies to certain distributions to foreign investors.

The Tax laws Amendment (2010 Measures No. 1) Act 2010 provided for the capital account election reforms. This Act received Royal Assent on 4 June 2010. The extended definition of an MIT for the purposes of eligibility for the lower rates of withholding tax for certain distributions to foreign investors was contained in the Tax Laws Amendment (2010 Measures No. 3) Act 2010 which received Royal Assent on 29 June 2010.

These amendments to the Australian tax laws relating to the taxation of MITs and distributions made by MITs are generally good news. However, the process of dealing with various representations relating to changes to the legislation while it was in draft form and then as it passed through Parliament, has resulted in the legislation being quite technically complex. The process and rapidity of changes made to the legislation is reflected by the fact that changes were subsequently made to the capital account election provisions contained in the Tax Laws Amendment (2010 Measures No.1) Act 2010 by the Tax Laws Amendment (2010 Measures No. 3) Act 2010.

Capital Account Election

A new Division 275 has been inserted into the Income Tax Assessment Act 1997 in order to provide MITs with the ability to allow the trustee of those MITs to make a choice that certain assets of the MIT be subject to the CGT rules. If no such choice is made by the trustee of a MIT, assets (other than land) will be treated as revenue assets and the CGT regime will not apply.

What constitutes an MIT for the purposes of Division 275 is determined by reference to the definition of that term in the withholding tax provisions contained in Schedule 1 of the Taxation Administration Act 1953 (as those provisions have been amended by the Tax Laws Amendment (2010 Measures No. 3) Act 2010). However, certain revisions to that definition apply for the purposes of Division 275. A summary of the new MIT definition is provided below.

The assets in respect of which a capital account election may be made are:

  • a share in a company (including a share in a foreign hybrid company)
  • a non-share equity interest in a company (eg. a legal form debt interest which is treated as equity under the debt/equity tax rules)
  • a unit in a unit trust
  • land (including an interest in land), and
  • a right or option to acquire or dispose of any of the foregoing assets.

Not eligible for the capital account election are assets that are debt interests (under the debt/equity tax rules) or financial arrangements under the taxation of financial arrangements (TOFA) tax provisions.

In order to make the capital account election the MIT must not be a trading trust for the purposes of the public trading trust provisions in Division 6C of the Income Tax Assessment Act 1936 or a corporate unit trust for the purposes of Division 6A of that Act.

An election for capital account treatment must be in force for the income year in which the CGT event happens. For trusts that become MITs in the 2009-10 or later income years, the choice must be made on or before the later of: the required date for lodgement of a tax return for the income year in which it became an MIT or such later day allowed by the Commissioner of Taxation. For other MITs, the election must be made on or before the latest of:

  • 3 September 2010 (which is 3 months after commencement of the provisions)
  • the last day of the 2009-10 income year, and
  • at such later day as may be allowed by the Commissioner of Taxation.

MIT Definition

The Tax Laws Amendment (2010 Measures No. 3) Act 2010 makes significant changes to the definition of a MIT which appears in Schedule 1 of the Taxation Administration Act 1953 – which provisions deal with withholding tax on certain distributions by MITs. As indicated, this definition is also relevant for capital account election purposes, although it has been modified in certain respects for application to those provisions.

General Requirements

The definition of MIT distinguishes between:

  • registered MITs with wholesale membership. Briefly, a trust will have wholesale membership if all its unitholders are wholesale clients under the Corporations Act (although the trust may be allowed less than 20 retail unitholders and still maintain wholesale membership)
  • registered MITs with retail (or non-wholesale membership); and
  • unregistered MITs with wholesale membership.

Different tests are required to be satisfied for each category for MIT. However, there are a number of common tests that need to be satisfied in the case of all MITs. These are:

  • at the time the trustee makes the first fund payment in relation to the income year, or at an earlier time in the income year, the trustee was an Australian resident or the central management and control of the trust was in Australia
  • the trust is not a trading trust for the purposes of the public trading trust provisions
  • a substantial proportion of the investment management activities for the trust must be carried out in Australia throughout the year of income as regards assets that are situated in Australia, assets that are taxable Australian property and assets that are listed on an approved Australian stock exchange. (This element of the definition is not relevant for capital account election purposes); and
  • at the time the payment is made the trust is a managed investment scheme as defined in section 9 of the Corporations Act 2001.

Further requirements – registered trusts with wholesale membership

Additional requirements to be satisfied by a trust that is registered under section 601EB of the Corporations Act and which has wholesale membership in order to be treated as a MIT are:

  • the number of retail investors is not more than 20 and those investors do not have a participation interest in the trust of greater than 10%
  • the trust is not required to be registered in accordance with section 601ED of the Corporations Act
  • the trust satisfies a widely held test requiring at least 25 members. The number of members is calculated in accordance with specified requirements, which involve uplifting the number of deemed members if units are held by certain specified entities such as life insurance companies, complying superannuation funds, other MITs or certain collective investment vehicles under foreign law (Specified Entities). Alternatively, the trust will satisfy the widely held test if one or more Specified Entities hold an interest exceeding 25%, provided that no entity other than a Specified Entity holds an interest of more than 60%
  • the closely held restriction is satisfied. This requires that 10 or fewer persons (not including Specified Entities) not hold a participation interest of 75% or more and that a foreign resident individual not hold a participation interest of greater than 10%
  • at the time of the first fund payment the trust is operated or managed by a financial services licensee holding an AFSL whose licence covers it providing financial services to wholesale clients or by an authorised representative of such financial services licensee.

Further requirements – unregistered trusts with wholesale membership

The additional requirements to be satisfied by a trust that is not required to be registered under section 601EB of the Corporations Actand which has wholesale membership in order to be treated as a MIT are:

  • the number of retail clients is not more than 20 and those investors do not have a participation in the trust of greater than 10%
  • the trust is not required to be registered in accordance with section 601ED of the Corporations Act
  • the trust satisfies the 'at least 25 members' widely held test (referred to above)
  • the closely held restrictions (referred to above) are satisfied
  • the requirements concerning the operation or management of the trust (referred to above) are satisfied.

Further requirements – registered trusts with retail (or non-wholesale) membership

The additional requirements to be satisfied by a trust that is registered under section 601EB of the Corporations Act and which has retail (or non-wholesale) membership in order to be treated as a MIT are:

  • units in the trust are listed for quotation on an approved Australian stock exchange or the trust has at least 50 members, and/or
  • specified Entities have a total participation interest of more than 25% at the time the first fund payment is made, but no entity, other than a Specified Entity, holds a participation interest of greater than 60%
  • the closely held restrictions (referred to above) are satisfied.

Action needed

The significant amendments to the definition of MIT for the purposes of the withholding tax provisions in Schedule 1 of the Taxation Administration Act apply to income years from 1 July 2010.

Generous 'grandfathering' relief may potentially apply for up to the next 7 income years for trusts that may have qualified under the predecessor version of the MIT definition.

It is evident that the definitional changes are complex and warrant careful analysis in order to determine whether a trust may be able to qualify as a MIT and be able to benefit from the lower rates of withholding tax and the ability to make a capital account election.

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.

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