Australia: Managed Funds: Changes To The Eligible Investment Business Rules

Last Updated: 6 October 2008
Article by Stephen O'Flynn

Tax Laws Amendment (2008 Measures No 5) Bill 2008 was introduced into Parliament on 25 September 2008, it included changes that were intended to make it easier for managed funds to comply with the law by reducing the scope for them to inadvertently breach Division 6C (i.e. the public trading trust rules that can tax a trust as a company). Whilst we are pleased that the meaning of "investing in land" has been broadened, it is unfortunate that the Bill falls short of providing greater certainty for most property trusts, as the proposed safe harbours included in the amendments do not provide any greater certainty than the current law and property trusts will largely be required to rely upon the existing rules when determining what is incidental income.

Key changes include:

  • Clarifying the scope and meaning of investing in land - The meaning of "investing in land" for the purpose of deriving rent is broadened to include investing in fixtures and moveable property (i.e. chattels) which is customarily supplied, incidental and relevant to the renting of the land and ancillary to the ownership and use of the land.
  • Introducing a 25% safe harbour for other non-rental, non-trading income from investments in land - A safe harbour will be introduced where 75% of the gross revenue is rent and none of the (25%) balance of gross income is "excluded rent" or from the carrying on of a business that is not incidental and relevant to the renting of the land.

Excluded rent will now only include rent worked out by reference to profits under an arrangement designed to result in a shift of substantially all of the profits to another party. Mercifully, turn-over rent which was previously included in the definition of "excluded rent" in the draft bill is not included in the Bill.

A potential uncertainty for trusts will be determining what income is incidental to rent. The explanatory memorandum (the "EM") notes a car park for customers of a shopping centre where fees are charged for long stays would be regarded as incidental. However, income for a car park as part of an office building that is opened to the public as a separate operation (and not primarily for the tenants) would not be regarded as incidental and so would fail the 25% test.

The safe harbor is meant to allow trusts to more easily demonstrate that it is investing in land for the primary purpose of deriving rent. However, in so doing the EM gives a clearer indication of what is rent and more importantly what is not. For some property trusts this has the potential to unsettle some "reasonably arguably" positions, especially in relation to certain infrastructure investments.

  • Expanding the range of Financial Instruments – The range of financial instruments under the eligible investment business rules will be expanded to the broader class that is defined as 'financial arrangements' in ITAA 1997. Certain "excepted arrangements" such as luxury car leases, guarantees and insurance policies will be specifically excluded from qualifying as financial arrangements.
  • 2% safe harbour at whole of trust level for non-trading income – Up to 2 % of the gross revenue of the trust can be from non-eligible investment business before the trust is treated as carrying on a trading business. However, income from other trading activities (from carrying on a business that is not incidental to an eligible investment business) is not included in the 2% amount. As such, the 2% safe harbour is of fairly limited value for most property trusts as it is arguable that incidental income is allowed under the existing rules and it is not limited to 2%.

The explanatory memorandum does explain that the 2% concession will apply to revenues such as:

  • directors' fees;
  • certain option or guarantee fees; and
  • investment income from non-financial arrangements.

These changes will apply in the income year in which the Bill receives Royal Assent. However, a trust that chooses to remain a trading trust may elect that the safe harbours do not apply so that they continue to be taxed like a company. 

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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