In the final days of the Federal Parliament, the Turnbull Government has enacted a package of tax reforms to give effect to the much-awaited new tax system for managed investment trusts (MIT).1 According to the ATO, the "new rules are intended to reduce complexity, increase certainty and minimise compliance costs for MITs and their investors". The reforms are intended to open up Australian investment to more overseas investors, especially the large pension funds and life insurance companies looking for new investment opportunities.
Unfortunately with 190 pages of Explanatory Memorandum and 137 pages in the main Act, the reforms are not easily summarised and require a detailed analysis to determine the impact on local as well as foreign investors, venture capitalists, trustees, management investment companies and even custodians.
In addition to the tax reforms the Budget also contained investment reforms as part of encouraging foreign investment.
The Treasurer announced that the Government will introduce two new collective investment vehicles (CIV) for overseas investors to pool their funds with Australian funds managers:
- The Corporate Collective Investment Vehicle will be available from 1 July 2017 and will allow Australian funds managers to offer investments through a company structure, which is well suited for offering retail investment products.
- From 1 July 2018 the Government will also introduce a Limited Partnership Collective Investment Vehicle. This type of vehicle is commonly used overseas to facilitate wholesale investment by large investors, such as pension funds.
Both vehicles will have flow-through status for tax purposes and similar eligibility criteria as the MITs, to encourage foreign investment when the APEC Asia Region Funds Passport Regime comes into effect on 30 June 2016.
The new CIVs will be required to meet similar eligibility criteria as managed investment trusts, such as being widely held and engaging primarily in passive investment.
The tax reforms effectively create two regimes with different tax treatment:
- Managed Investment Trusts (MITs) dealt with by Division 6 of Part III of the Income Tax Assessment Act 1936, and
- Attribution Managed Investment Trusts (AMITs) dealt with by the new Division 276 of the Income Tax Assessment Act 1997 from 1 July 2016 (the new division uses a different definition of MIT).
- Implications for trustees of MITs
Trustees will need to decide whether to become an AMIT knowing that the decision once made cannot be revoked and that Division 6B, which taxes corporate unit trusts similarly to companies, will be repealed with effect from 1 July 2016. Trusts that cease to be subject to Division 6B will be permitted to make franked distributions to unitholders until 30 June 2018.
In making the decision, trustees need to consider a number of issues including whether or not their Trust Deeds and constituent documents require modification before an election can be made.
In some cases, a trust may now come within the new definition of an MIT by virtue of the new definitions and the expanded list of eligible members.
Specific issues to be considered include determinations of whether:
- members have clearly defined rights or not
- the trustee of an MIT will be taxed at 30% on income determined by the Commissioner to be "non-arm's length income" less any deductions attributable only to that income
- the trustee has discretion over the entitlements of members
- product disclosure statements and marketing materials need to be modified
- changes are required to the accounting and tax management processes to apply the AMIT regime, in particular the design and implementation of protocols and computing to determine breakdowns for each member's AMIT Member Annual (AMMA) statements as per the statutory formula for each required component, and
- the new MIT regime will also require changes to operations, service arrangements, reporting to investors and product planning and development withholding obligations.
Eligible investors will include:
- A foreign life company regulated under a foreign law.
- A pooled superannuation trust that has at least one member that is a complying superannuation fund with at least 50 members.
- An entity recognised by foreign law as being a collective investment scheme with at least 50 members that don't have day-to-day control over the entity's operation.
- A complying superannuation fund or foreign superannuation fund that has at least 50 members.
- A limited partnership, so long as throughout the income year
- at least 95% of the membership interests are directly or indirectly owned by eligible investors
- the remaining membership interests are owned by a general partner that habitually exercises the management power of the limited partnership, and
- an entity that is directly or indirectly a wholly-owned subsidiary of the entity is an eligible investor, or two or more entities are eligible investors.
- A trust not required to be registered under s 601ED of the Corporations Act 2001 (Cth) (Corporations Act) has less than 20 retail members and the retail members have a total MIT participation of less than 20%.
Eligibility as an AMIT
To qualify as an AMIT a trust must:
- Be a MIT for tax purposes. This means the trust must
- have an Australian resident trustee or central management and control in Australia
- not carry on or control a trading trust
- be a managed investment scheme as defined in the Corporations Act
- be sufficiently widely held, and
- be operated or managed by an AFS licensee.
- Have members of the trust with clearly defined interests in relation to the income and capital of the trust, meaning that
- there is an objective benchmark for the attribution of the tax consequences of the trust's activities to its members
- the trustee doesn't have significant discretionary powers to determine a particular member's rights to income or capital of the trust or to determine the income distributed to a member, and
- registered funds are deemed to have clearly defined interests.
- In the case of unregistered funds, the test will be whether or not the trust constitution and supporting documents such as the PDS and other documents, including the unit holder's agreement, clearly define the member's rights to income and capital arising from their membership interests in the Trust as the same (excluding differential fees charged between unit holders and different issue/redemption pricing).
- Have an irrevocable election made by the trustee to apply the new tax system from a specific income year.
Benefits of AMITs
The trust will be treated as a fixed trust for income purposes. Each entity that is a member of the AMIT for an income year is taken to have a vested indefeasible interest in a share of the income and capital of the AMIT throughout the income year. The replacement of the "present entitlement" model for distributing trust income will be a more streamlined process, as entitlements are attributed to unitholders based on their "clearly defined interests" and the statutory formula. AMITs with multiple classes of units will be able to treat each class of units as if it is a separate trust and apply the attribution method only to that class.
For income tax purposes, the trustee will be able to attribute taxable income, exempt income, non-assessable non-exempt income, tax offsets and credits to members on a fair and reasonable basis based on the interests in the trust document.
Additional obligations will apply to trustees of AMITs including the production of AMMA statements and their retention. AMMA statements must be given within three months of the end of the income year.
The "under and overs" regime will allow the trustee to reconcile variances between amounts attributed to members for an income year. Amounts that should have been attributed can be carried forward into later years on a character–by-character basis.
Benefits for members of an AMIT
Amounts derived or received by the trust and attributed to members will retain the character they had in the hands of the trustee, that is, character flow-through.
Members will be able to make arrival upward/downward or adjustments to the cost bases of the trust interest and so reduce uncertainty in relation to their taxation.
The AMIT transitional rules provide that tax free and tax deferred distributions paid on or after 1 July 2011 and before the starting time will be non-assessable if the trust becomes an AMIT for the starting income year. The exception is where distributions were included in the assessable income of a member.
The starting income year will be the first income year starting on or after 1 July 2017 unless the trustees choose the early "opt in" for the income year starting on or after 1 July 2015.
Members must be given an AMMA statement that sets out the member's entitlements to assessable income, exempt income and non-assessable non-exempt income; tax offsets; discount and non-discount capital gains; dividends, interests, or royalties subject to withholding tax; and foreign source income.
Debt-like investments issued by the trust will be treated as debt interests for the purposes of working out if the MIT will qualify as an AMIT and applying the attribution model.
PAYG withholding provisions and the withholding tax liability provisions apply to AMITs with foreign residents.
Trustees Action Plan before 1 July 2016
Before 1 July 2016 trustees need to consider these reforms and their implications in terms of an election to become an AMIT and, if so, what year should be the relevant starting year.
From a compliance perspective, trustees should conduct a detailed compliance audit to determine the impact of the AMIT Regime to assess if the trust is eligible to apply the AMIT reforms.
Trustees also need to:
- Review their trust deed and constituent documents and decide whether
- the trustee has discretion that needs to be removed or modified
- review all relationships in terms of the non-arm's length rule including arrangements with related parties, cross staple loans, management services agreements and rental leasing agreements
- members have "clearly defined rights"
- the present wording for the determination and distribution of income permits the new "attribution" model and statutory methodology to be used, and
- it is possible to stream the rights attaching to particular classes of membership interests in the MIT as contemplated by the reforms.
- Review systems to determine if they meet or can be modified to meet the requirements of the reforms, including determining attributable income under the "attribution model".
- Review current distribution information to unitholders and ensure they can process the information required to produce the required AMMA reports.
We can help you work your way through the reform maze including reviewing and modifying your trust documents and assisting with the compliance regulatory aspects of the reforms.
1 The Tax Laws Amendment (New Tax System for Managed Investment Trusts) Act 2016 (the Act), received Royal Assent on 5 May 2016. The new rules apply from 1 July 2016. However, a trustee of a MIT can choose to apply the rules from 1 July 2015.
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.