Australia: Treasury Releases Discussion Paper - New Managed Investment Trust ("MIT") Tax System

Moore Tax News
Last Updated: 20 October 2010
Article by Nick Zanikos

On 18 Octobeer 2010 the Assistant Treasurer, the Hon Bill Shorten MP, reeleased a discussion paper on the design and implementation details of the Government's proposed new tax syystem for MITs. The discussion paper follows the Government's previous announcement on 7 May 2010, in w which it provided an initial response to the Board of Taxation's report into the tax arrangements applying to M MITs. The proposed new MIT tax system builds upon thhe existing MIT withholding tax rules and capital account eleection concession for MITs.

The current discussion paper has been released to seek the public's inittial views on how to best implement a new tax system for MITs. In particular, stakeholders are asked to considder a number of specific problems that have been ide entified by Treasury as it seeks to implement the recommenddations of the Board of Taxation.

It is proposed that the key features of the new MIT tax system will include:

  • An elective attribution system of taxation under which investors will be taxed only on the income that the trustee of f the MIT allocates to them on a fair and reasonable basis, consistent with their entitlements under the MIT's deed and other constituent documents;
  • Allowing MITs to carry forward errors in the calculation of their taxable income (i.e. unders and overs) to the following income year, provided that the amount of the under or over does not exceed a de minimis level;
  • Removing double taxation that can arise in certain circumstances by introducing new cost base adjustment arrangements; and
  • Introducin ng a general principle of character and source retention for MIT distributions to unitholders. The commentary below considers the key features of the proposed new MIT tax system and some of the problems raised by the discussion paper in relation to each.

Elective atttribution method of taxation

Under the new MIT tax system, MITs will be able to choose an attributioon method of taxation, rather than use the present entitlement to income method in Division 6 of Part III of the ITAA 1936. This new method of taxation will only be available where the unitholders of the MIT have "clearly defined rights or entitlements".

The elective attribution method of taxation will allow MIT unitholders to be taxed only on the income that the trustee allocates to them on a fair and reasonable basis, consistent with their rights/entitlements under the MIT's deed annd other constituent documents (e.g. product disclosure satements, minutes specifying the terms for the issue of units, etc).

MIT unitholders must have clearly defined rights/entitlements as a pre-condition for the use of the attribution method of taxation because unitholders and the Commissioner must be able to confidently determine the unitholders' tax liability in relation to their allocation of the relevant MIT's tax income.

The 'clearly defined rights/entitlements' requirement is satisfied if the unitholders' rights to income (including the character of the income) and capital are clearly established at all times in the MIT's constituent documents. It is proposed that rights/entitlements should only be able to be changed by an amendment to the trust's constituent documents. A legislative mechanism is likely to be used to ensure that material discretionary elements in the MIT's constituent documents will cause an MIT to fail l the clearly defined rights/entitlements requirement.

The discussion paper asks interested parties to conssider whether some types of MITs (e.g. registered MITs) should be deemed to automatically satisfy the clear rly defined rights/entitlements requirement. This may be appropriate where other rules (such as provisions of the Corporations Act) already operate to prohibit a particular type of MIT from acting in a manner that is inconsistent with the proposed attribution method of taxation.

Interested parties are also asked to consider whether it would be possible for the clearly defined rights/entitlements requirement to be satisfied where a trustee has a power to accumulate income in the trust or issue units at a significant discount, without impacting on the integrity of the rules.

Unders and overs – carry forward arrangements

Under the new MIT tax regime, MITs will be able to carry forward errors in the calculation of their net income (i.e. unders and overs) to the following income year, provided that the amount of the under or over does not exceed a de minimis level. This means that the trustee will not need to issue revised distribution statements to unitholders and assessments made in accordance with the original distribution statements do not need to be amended.

The Board of Taxation recommended that the de miniis level should be the greater of:

  • 5% of the net (taxable) income of the trust for the relevant income year; and
  • A prescribed dollar value per unit.

The discussion paper asks interested parties for input in developing the prescribed dollar value per unit deminimis threshold, which Treasury considers to be problematic. A simple example is used to illustrate the problem – two MITs, A and B, have the same net wo orth but MIT A has 10 times the number of units as MIT B. As the actual net worth per unit for B is 10 times thatt for A, a prescribed dollar value per unit test is likely to be far more generous for A than for B.

The discussion paper also asks interested parties to comment on potential problems that may arise under the carry forward approach, and to suggest possible resollutions. For example, there may be an insufficient amount of taxable income in a current income year to absorb the MIT's overstated taxable income from the prior year.

Where the amount of an under or over exceeds the de minimis level, the trustee will be required to reissue distribution statements to beneficiaries and undertaake a revised attribution of tax income. If the revised distribution statement is not issued within a specific period, trustee will be assessed on any tax shortfall at the top marginal tax rate (currently at 46.5%). If there is no tax shortfall but the trustee fails to reissue statements it is proposed that a standard administrative penalty will apply.

Cost base adjustments

New cost base adjustment arrangements will apply to MITs that choose to use the attribution system of taxation and to those that continue to use the present entitlem ment to income method in Division 6 of Part III of the ITAA 1936. These cost base adjustments are intended to prevent double taxation where a unitholder would be taxable on the attributed tax income of an MIT and may also be taxable on a gain on the sale of the units which would reflect the value of the undistributed amount which has already been subject to tax.

Under the new cost base adjustment arrangements, the cost base (or reduced cost base) of units would be adjusted as follows:

  • Where tax income is attributed to a unitholder, then the cost base of the unitholder's units is to be increased by the amount attributed (adjusted upwards for certain amounts that are otherwise disregarded for CGT event E4 such as the discounted component of a capital gain and downwards to reflect the value of certain tax offsets such as the gross up component of a franking credit); and
  • The cost base will be reduced by the amount of:
    • Any distributions of tax income that have previously been attributed; and
    • Distributions of tax preferred amounts to unitholders that do not hold their units on revenue account, other than the amount attributable to a CGT discou unt.

The discussion paper asks interested parties to consider the appropriaten ness and effectiveness of such cost base adjustments and the nature of any reporting obligations to unitholders th hat should be imposed on trustees.

Character and source retention

The discussion paper proposes amendments to the law to provide a general principle of character and source retention for MIT distributions to unitholders. The Government seeks consultation on how such a rule should be designed, whether the proposed approach is workable in practice e and whether alternative approaches should be con nsidered.

Submissions on the discussion paper close on 15 November 2010. Mooore Stephens will be participating in this consultation pprocess. We invite our clients and other readers to review the discussion paper and advise us if they have any concerns which they would like us to put forward on their behalf.

The exposure draft legislation is expected to be released later this year.

Government delays comment on proposed changes to o definition of "eligible investment business"

The Board of Taxation's May 2010 report into the tax arrangements applying to MITs recommended a more flexible defini ition of "eligible investment business". This matter was high hly important to real estate investment trust managers seeking to offer innovative property investment products while retaining fiscally transparent tax treatment for investors. The discussion paper discussed herein does not aaddress this recommendation, but it is understood that the Government may further examine this recommendation at a later time, relative to its cost to revenue.

On 18 Octobeer 2010 the Assistant Treasurer, the Hon Bill Shorten MP, reeleased a discussion paper on the design and implementation details of the Government's proposed new tax syystem for MITs. The discussion paper follows the Government's previous announcement on 7 May 2010, in w which it provided an initial response to the Board of Taxation's report into the tax arrangements applying to M MITs. The proposed new MIT tax system builds upon thhe existing MIT withholding tax rules and capital account eleection concession for MITs.

This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2009 Moore Stephens Australia Pty Limited. All rights reserved.

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