The public release of the draft legislation for the proposed new tax regime for managed investment trusts (MITs) is a significant step towards realisation of a regime that has been in development for almost five years. Trusts, including MITs, are a common feature within the infrastructure sector.
The new regime will apply to trusts that are Attribution Managed Investment Trusts or AMITs, which are broadly MITs under the existing definition in the tax law (with some minor changes) where the interests of members in the trust are clearly defined. Under the new regime, trust components (which include both taxable income and some non-taxable amounts) will be allocated or attributed to members of the trust on a fair and reasonable basis, rather than based on present entitlement to “income” of the trust as per the current tax law. A detailed overview of the proposed new regime can be found in PwC’s Tax Talk Alert Draft legislation for proposed new Managed Investment Trust regime released.
While the proposed new regime goes some way to addressing the difficulties in applying the current trust tax law provisions to MITs, the proposed rules are complex and feature a range of new obligations and potential penalties that must be carefully considered.
The draft legislation also proposes some positive changes to the existing definition of MIT contained in the tax law, and makes some other minor related amendments.
After many years of consultation, the Government has released draft legislation for the proposed new tax regime for MITs.
The draft legislation reflects the previously announced start date of 1 July 2015 for the new regime. However, it is understood that the Government intends to defer the start date for another year, such that the new regime will apply to income years starting on or after 1 July 2016 with an option to elect in one year earlier (for income years commencing on or after 1 July 2015).
Again, whilst not addressed in the draft legislation, it is understood that existing MITs will need to exercise a choice to adopt the new MIT regime.
Below, we have highlighted a number of key issues that should be considered – two of these relate to the proposed new attribution model, and two relate to the other amendments contained in the draft legislation.
Project financing – Trust Constitution Amendments
The proposed attribution model of taxation for AMITs may solve or at least reduce some existing problems associated with the taxation of trusts and the requirement for members to be “presently entitled” to the income of the trust for the tax liability to flow out to members. This has caused issues in the past, particularly where the trust is in “lock-up” under its project finance debt documents. The trust may have net taxable income but may be precluded from making a distribution of cash or property. This can result in trustee tax liabilities at the highest marginal tax rate (as there is no beneficiary presently entitled) or a breach of the trust constitution and/or debt documents where members are “deemed” to be presently entitled to an amount equal to (at least) the trust’s taxable income.
The proposed attribution model effectively “de-links” the distribution of cash (or property) from the tax liability in respect of the trust’s taxable income, shifting this liability to members without the trust having to make any distribution. This also removes the need for “deemed” present entitlement provisions in trust deeds.
Whilst this is likely to require trust deed amendments in almost all cases (and brings with it the risk of trust resettlements, although the Australian Taxation Office has previously provided a view that certain changes to a trust deed should not give rise to income tax consequences), it should assist in resolving some of these issues. Careful consideration will still be required regarding arrangements to fund any withholding tax liability arising in respect of “fund payments” to non-residents which, under the proposed new rules for AMITs, can arise without there being any associated payment to the non-resident.
The new arm’s length rule
The introduction of an arm’s length rule in the AMIT regime is a significant change to the current tax law which has no equivalent domestic transfer pricing rule. The arm’s length rule has been drafted quite broadly such that AMITs will likely need to consider all arrangements with related parties, including cross-staple loans, management agreements, and rental and licencing arrangements. A limited transitional rule has been included to allow existing AMITs to restructure their existing arrangements before 1 July 2017.
The inclusion of “safe harbours” for returns on debt interests is welcome, although there is still concern regarding income received by an AMIT in the form of distributions from sub-trusts (notwithstanding the carve-out for distributions from trusts that are not party to the scheme under which the AMIT derived the income).
The ongoing compliance costs associated with the application of the arm’s length rule are likely to be significant, including complying with any financier requirement. In addition, the test appears to be a yearly one, so it may be difficult to achieve certainty over a sustained period of time.
Amendments to Division 6C (public trading trusts)
The amendments to remove the “20 per cent” rule for superannuation funds (and other exempt entities eligible for a refund of franking credits) investing in public trading trusts is a welcome change that will present opportunities for superannuation funds to invest directly in trusts that operate or control or control the affairs of another entity that operates a trading business without loss of flow through status for the trust. Superannuation funds that in the past have set up “blocker” companies may wish to consider removing these from existing structures to minimise costs, having regard to any tax, stamp duty or other issues associated with the transfer of the interests held by these blocker companies. This amendment will apply from 1 July 2015.
Investing in MITs….who and how
The proposed changes to the definition of MIT for withholding tax purposes from 1 July 2014, in particular the types of entities that can be “qualifying investors”, provides an opportunity to reassess commonly used structures for investing in infrastructure projects. The ability to use “blocker” companies that are wholly owned by qualifying investors is a welcome change.
The wholly owned subsidiary expansion fails to recognise the extensive use of limited partnerships in foreign jurisdictions. Limited partnerships are the predominant international pooling vehicle, and yet again, Australia’s tax law has failed to recognise this, such that a limited partnership which has only qualifying investors as its limited partners will not be treated as a qualifying investor unless the general partner is also a qualifying investor. This could have been easily be rectified in the draft legislation.
Assuming the final law is amended to provide existing MITs with a choice to adopt the new regime, trustees of existing MITs will need to carefully consider the potential implications of the new attribution regime in deciding whether to adopt it. The new attribution regime will also need to be considered when contemplating new infrastructure deals.
The benefit of increased certainty afforded by many of the features of the new regime will need to be carefully weighed against the new obligations and possible penalties, including the arm’s length rule which is likely to lead to a substantial increase in compliance costs.