Originally Published 29th July 2008
After 23 years and extensive industry consultation the Federal Treasury has released draft legislation to amend the public trading trust rules. The Government has promised that the new legislation will reduce compliance costs for managed investment trusts and will resolve some of the uncertainty around the key features of the current law.
The key features of the draft legislation provides for the following changes:
- clarifying the scope and meaning of investment in land for the purpose of deriving rent;
- introducing a 25% safe harbour allowance for non-rental, non trading income from investments in land (however, beware the fine print!);
- expanding the range of financial instruments that a managed fund may invest in or trade; and
- providing a further 2% safe harbour allowance at the whole of trust level for non-trading income (as opposed to an asset by asset basis).
So what does this all mean?
- property trusts with plain vanilla property investments will be mostly unaffected by the changes; and
- unfortunately the draft legislation is unlikely to resolve much uncertainty for property funds with more exotic arrangements. In some respects, the draft raises as many questions as answers. It is hoped that these questions will be appropriately resolved during the remaining consultation process.
Our main concerns are:
- the safe harbour is tested at the trust level therefore for 100% owned groups the tests must be carried out on a trust by trust basis. So much for simplification!
- whilst the 25% safe harbour at first glance appears to be a significant improvement, it does not provide the security that you would expect. Our main concern is that if any of the income of any trust is considered to be:
- "excluded rent"; or
- from the carrying on of a trading activity on a commercial basis on the land, then the safe harbour will be failed and the trust will be required to rely on the law as it stands now. Importantly, as the safe harbour is tested at the trust level it only takes one property deriving excluded rent within the trust to make the 25% test inapplicable;
- Examples of "excluded rent" include:
- turnover rents where parties are not dealing at arm's length; and
- profit based rents; The existing draft falls short of clarifying in precise terms what the two limbs of this definition mean. It is hoped that greater clarity will be forthcoming either by way of refinements to the legislation or at the very least in the Explanatory Memorandum to the final Bill.
- Unfortunately the draft legislation does not make clear what will be considered to be "a trading activity on a commercial basis on the land". As such, funds operating car parks, short term storage facilities, tollways and other non-traditional rental arrangements will remain unclear as to the treatment of these assets under the proposed changes, unless further clarification is provided. Given the approach taken in the proposed changes in relation to profit based rentals (and also having regard to what seems to be the prevailing view of the Commissioner) it would seem more likely than not that such arrangements would represent trading activities and may be detrimental to the tax status of a fund;
- The term "gross revenue" which is the basis for the 25% safe harbour is not defined in the draft. Given the importance of this term, it is important that further clarification be provided. The draft provides that gross revenue excludes capital gains arising from CGT event A1, but no further embellishment appears to be offered at this stage, so it is not entirely clear what the term is intended to mean. Is it intended to be based on accounting concepts? Is it intended to equate with gross assessable income for income tax purposes? These questions will hopefully be addressed before the legislation is finalised, but it is apparent that for any property trust any turnover that is not rental income (other than the CGT exclusion referred to above) will need to be 25% or less of total turnover;
- The main difficulty with the new 2% tolerance concession is that its benefit would seem extremely limited – curiously, it only allows for a maximum of 2% of gross revenue from activities other than trading activities. One questions whether this amendment will be of much value.
On a somewhat brighter note:
- Treasury has taken a practical common-sense approach to what is likely to fall within the definition of "investing in land". The draft legislation explains that investment in land will include an investment in moveable property customarily supplied, incidental and relevant to the renting of the land and ancillary to the ownership and utilisation of the land; and
- the list of eligible investments which are able to be held by public trusts without breaching Division 6C are proposed to be broadened to include a variety of financial arrangements. However, there are a number of carve-outs from this extension that are of concern and on which further clarification is necessary.
Submissions in response to the draft legislation can be made to Treasury by August 14. Moore Stephens will be making submissions and we would welcome any input (or queries in the meantime) from clients in the property sector.
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.