A welcome announcement in the May 2009 Federal Budget was to provide deemed capital account treatment for gains and losses made on disposal of investment assets by Australian managed investment trusts (MIT). The announcement goes some way to alleviating concern as to the appropriate taxation treatment on disposal of investment assets by funds and whether gains or losses should be treated on capital or revenue account.
Concern had been sparked by a threatened Tax Determination in 2008 in which, it is understood, the Australian Taxation Office would have adopted the position that most gains by MITs on the disposal of assets should be treated as being on revenue account. This would follow the reasoning adopted in Ruling TR 2005/23 – which applied to the treatment of gains from the disposal of assets by listed investment companies.
The Budget announcement proposes a regime whereby an Australian MIT could make an irrevocable election to apply capital gains tax (CGT) to disposals of "eligible assets", which would generally comprise shares, units and real property. Australian resident investors investing in such MITs would thereby be entitled to the CGT discount on eligible taxable gains distributed by the MIT.
Non-resident investors would be exempt from Australian tax on distributions of gains on eligible MIT assets unless the assets are "taxable Australian property". That term is defined in the CGT rules applicable to non-residents and comprises Australian real estate, certain indirect interests in Australian real estate and assets used in carrying on business through a permanent establishment in Australia. Accordingly, based on the announcement, the tax relief offered to non-residents where the MIT invests in Australian real estate may be limited.
The proposal was stated in the Budget announcement to apply to Australian MITs and to units trusts that were wholly owned and controlled by MITs that meet the eligible investment rules in the public trading trust tax rules. Trusts that, under the tax rules, are taxed on a similar basis to companies – such as public trading trusts and corporate units trusts – would not qualify for the treatment and, in any event, would have little benefit in being subject to CGT treatment.
The announcement also mentioned that an integrity rule would be introduced so that, once the capital account election is made, it is irrevocable and will apply to all disposals of eligible investments commencing in the first income year after the 2008-09 income year. This is to reduce the incentive for MITs to dispose of existing assets and claim deductions for losses on revenue account against other income before the proposal becomes law or a capital account election is made.
Treasury Discussion Paper
On 1 June 2009 a Treasury discussion paper (Paper) was released outlining some of the key design features and canvassed details and issues relevant to giving effect to the capital account election.
The election is only available to MITs and the Paper indicated that the starting point for defining an MIT will be the regime in the Taxation Administration Act (TAA) that deals with the application of the withholding tax rules to MITs. A trust will be an Australian MIT where:
- the trust has a relevant connection with Australia. This connection may be by a trustee of the trust being an Australian tax resident or the trust's central management and control being in Australia. The connection must exist at some time during the income year up to and including the time of making the first fund payment. If no fund payment is made in an income year the paper indicates that consideration will be given to have the relevant time being the making of the first dividend, interest or royalty payment, where applicable, or both the first day and last day of the income year if no payments are made at all;
- the trust must be a "managed investment scheme" operated by a "financial services licensee" – as those terms are defined in the Corporations Act; and
- it satisfies the requirement that it be listed or widely held. This will be satisfied if it is listed on an approved Australian stock exchange, it has at least 50 members or it has less than 50 members but a member includes an entity of a specified kind. Those specified include, for example, a complying superannuation fund or foreign superannuation fund with at least 50 members. In a proposed departure from the definition in the TAA, it is not proposed to include life insurance companies on this list because their investments are typically held on revenue account. The paper indicates that comments are sought on this design issue.
Under the TAA definition of an MIT a trust is not taken to be widely held if any one foreign resident individual directly or indirectly: holds, or has the right to acquire, interests representing 10% or more of the value of the interests in the trust; has the control of, or ability to control, 10% or more of the rights attaching to "membership interests" in the trust, or has the right to receive 10% or more of any distribution of income that the trustee may make. The Paper indicates that comments are also sought on this design issue.
The Paper provided some further elaboration on "eligible assets" which can qualify for the capital account election. The assets cannot be "debt interests", Division 230 financial arrangements (under the new taxation of financial arrangements (TOFA) regime) or trading stock. Options canvassed in the Paper to implement the definition of "eligible assets" include:
- listing specific assets that could qualify for the election (such as shares, units and real property) and leave the treatment of other financial arrangements to the ordinary income rules, including TOFA where appropriate; or
- a rule similar to that in subdivision 295-B of the Income Tax Assessment Act 1997 which specifies CGT as the primary code for calculating the gains or losses of complying superannuation funds and which would exclude from such treatment non-equity financial arrangements and assets held as trading stock.
Where the trustee of a MIT makes the capital account election, the CGT regime will apply to disposals of eligible assets from the first income year commencing on or after the 2008-09 income year.
The setting of a start date does raise an issue of possible uncertainty concerning whether disposals of assets in prior years by MITs were properly treated as being on capital account. Questions are raised in the Paper as to whether an MIT making a capital account election can have assurance that prior year returns, where the MIT had self assessed disposals as being on capital account, will not be adjusted by the ATO. Also, if an election is made, whether it would be possible to amend prior year returns to obtain the best taxation outcome – whether it be on revenue or capital account, or whether there should be a legislative prohibition on amending prior year returns. The Paper indicates that comments are sought on possible solutions to this issue.
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.