In May this year the Government, in responding to the Board of Taxation Review of the Tax Arrangements applying to Managed Investment Trusts (MITs) proposed a number of significant changes to the taxation of MITs (see our Legal Update of 13 May 2010). In October this year the Government has released a Discussion Paper on the reforms proposed, as a basis for consultation on their legislative design and implementation.
The closing date for submissions on the Discussion Paper is 15 November 2010.
MITs to which the reforms are directed
The tax treatment of MITs has already been subject to significant changes. These relate to: the ability of MITs to apply capital gains tax treatment to the disposal of certain eligible assets (the so-called capital account election) and a reduced (7.5 per cent) rate of final withholding tax on fund payments from a MIT to foreign investors (see our Legal Update of 3 August 2010).
There is a definition of what trusts will be treated as MITs in the Taxation Administration Act 1953 (TAA) and which is relevant to the reduced rate of withholding on fund payments to foreign investors. This definition applies with some modifications to the capital account election provisions, so that some funds that may not otherwise qualify as a MIT under the TAA may nevertheless be treated as a MIT for capital account election purposes.
A possibility canvassed in the Discussion Paper is that the definition of a MIT which applies for the purposes of the capital account election, also apply so far as other features of the proposed tax reforms are concerned.
Attribution method of taxation
It is proposed that MITs be able to choose to use an attribution method of taxation rather than the current basis of taxation which is determined by reference to whether or not a beneficiary in the MIT (or trust) is presently entitled to a share of the income of the trust.
The guiding principles of the attribution method will be:
- The trustee must attribute the taxable income of the MIT to its unitholders on a fair and reasonable basis consistent with their rights and entitlements under the trust's constituent documents and the duties of the trustee.
- Unitholders will be subject to tax on the amount attributed to them by the trustee – following the trustee properly exercising its powers under the trust deed to attribute such income.
- Amounts so attributed will generally retain its character in the hands of a unitholder.
- Taxable income of the MIT not attributed to unitholders within 3 months of the end of the income year will be assessed to the trustee at the top individual marginal rate (46.5 per cent - including Medicare levy).
A condition to be able to use the proposed attribution method is that unitholders in the MIT have clearly defined rights and entitlements. This requirement will be satisfied if unitholders' rights to income and capital are clearly established at all times in the trust's constituent document and those rights should only be able to be changed by amendment of those documents.
Various ideas are canvassed in the Discussion Paper as to approaches to satisfy the "clearly defined rights and entitlements" requirement. The discussion is reminiscent of determining whether a trust may be treated as a "fixed trust" for tax purposes and there is the telling observation in the paper that "it is doubtful whether most MITs are able to qualify as a 'fixed trust' for tax purposes."
Dealing with unders and overs
An "under" arises where the trustee of a MIT reports the taxable income of the trust on which the trustee bases the distribution statement it gives to the beneficiaries after the end of the income year and the total taxable income reported is less than the actual taxable income. An "over" arises where the total taxable income on which the trustee of a MIT bases its distribution statement is more than the actual taxable income of the trust. The policy objective sought is that where the amount of an under or over is less than a de minimis level, the trustee need not issue revised distribution statements to unitholders and there is no need to amend assessments made in accordance with distribution statements.
A general carry forward approach is to apply for correcting net "unders" and "overs" below a de minimis level. This would allow for net unders and overs arising in a year of income to be carried forward into the MIT's taxable income calculation for the next income year following identification of the error.
The Board recommended that the de minimis level should be either 5 per cent of the taxable income of the trust for an income year or a prescribed dollar value per unit. One issue raised is how to set a suitable prescribed value per unit.
Where an under exceeds the de minimis amount, the trustee may reissue distribution statements and undertake a revised attribution of the trust's taxable income. If there is no such reissue of statements or reattribution within a specified period, the trustee would be assessed on the amount of the tax shortfall at the top marginal tax rate.
If an over is greater than the de minimis amount, there would be a requirement to reissue distribution statements within a certain period. Failure to do so may attract an administrative penalty.
Cost base adjustments
To address possible double taxation issues that can arise where the taxable income of a MIT differs from the amount distributed, it is proposed that the cost base of units held by a unitholder be adjusted in the following circumstances:
- where taxable income is attributed to a unitholder, the cost base of the units held would be increased by the amount attributed (subject to certain adjustments), and
- the cost base will be reduced by the amount of any distributions of taxable income that have previously been attributed to the unitholder, and distributions of tax preferred amounts to unitholders (other than is attributable to the CGT discount).
Other issues to be dealt with
The Discussion Paper canvasses a number of other tax issues proposed to be dealt with. These include:
- MITs which have clearly defined rights being treated as "fixed trusts" for tax purposes (ie. for the purposes of applying: the trust loss rules, dividend imputation, scrip for scrip rollover and the treatment of capital gains for foreign investors in the MIT)
- repeal of Division 6B ITAA36 which taxes "corporate unit trusts" on a similar basis to companies, and
- introducing an arm's length rule into the Division 6C public trading trust provisions where MITs enter into transactions with associated entities to transfer income or value and that have the effect of circumventing the "eligible investment business" rules in Division 6C.
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.