Long-awaited changes are (almost) here
On 9 April 2015, the Treasury released draft legislation and explanatory material setting out the proposed new tax rules for managed investment trusts (MITs). Public submissions are due on 23 April 2015.
These changes are intended to simplify, and provide certainty in relation to, a MIT investment. They also expand the scope of who can invest. The changes are generally proposed to apply from 1 July 2015.
What the changes mean and what you should do
- The attribution rules should make it easier for fund managers and trustees to allocate trust income and deal with under and over distributions (and the resulting tax liabilities) to unitholders of qualifying attribution MITs.
- MIT trust deeds and distribution mechanisms should be reviewed and amended where necessary to qualify under the new attribution rules. The trust deed should also allow attribution of taxable income to members in accordance with the new rules.
- MITs that do not provide clearly defined interests for their unitholders (such as those with discretionary income/capital allocations) cannot use the attribution rules, and will continue to be taxed under the general trust income taxation rules (based on "present entitlement").
- Structures that did not qualify as a MIT under the current law should also be revisited (for example, where investors are foreign life insurance companies or where eligible investors invest via wholly-owned entities such as a blocker company or limited partnership), as they could now qualify as a MIT under the broadened widely held requirements. More generally, we would expect to see structures including groups of eligible investors investing into MITs via a "MIT-compliant" offshore pooling vehicle, with non-eligible investors investing via a parallel "non MIT-compliant" entity. This change is intended to apply from 1 July 2014.
- Qualifying attribution MITs will be subject to a non-arm's length income test, under which the trustee is taxed at the top marginal tax rate plus relevant levies (currently 49%) for income derived by the attribution MIT from non-arm's length transactions with parties that are not attribution MITs.
The key changes
New attribution rules for qualifying attribution MITs
Applicable to income years starting on or after 1 July 2015, the rules (if enacted) will generally allow qualifying "attribution MITs":
- to use a new attribution model (instead of the often cumbersome general trust tax rules) and attribute specific classes of income, offsets and credits to its unitholders;
- to attribute any under or over distributions to unitholders during the year the variance is discovered (a transitional rule will apply to under and over distributions made by an existing MIT that becomes an attribution MIT in the 2015-16 income year); and
- to be treated as a fixed trust, which can assist in flowing franking credits and carrying forward tax losses.
To be a qualifying "attribution MIT", the trust deed needs to clearly define the unitholders' interests in the trust's income and capital at all times. For instance, a unitholder's right to trust income or capital cannot be materially diminished by any power or right, and the trustee needs to treat unitholders in a class equally and fairly. Discretionary and hybrid trusts would generally not satisfy the requirement.
Broadening the range of eligible investors for the widely held test
Applicable from 1 July 2014, the rules (if enacted) will broaden the range of eligible investors whose interest can qualify for the widely held requirements that must be satisfied by a MIT.
The eligible investors will include foreign life insurance companies regulated under a foreign law (the position of which is unclear under the current law) and entities wholly-owned by one or more eligible investors or their subsidiaries (not just entities wholly-owned by, for instance, certain foreign pension or public funds, as is the case under the current law). This should assist structures comprising blocker companies or limited partnerships wholly-owned by eligible investors which are outside the limited concession for foreign pension or public funds under the current law.
Better treatment of Australian super funds for Division 6C
Under the current Division 6C, if an Australian super fund holds 20% or more of an Australian trust that carries on a trading business, the trust can be deemed to be a company (and taxed at 30% on its income - rather than treated as a tax pass through).
Under the proposed changes, this 20% tracing rule relevant to Australian super funds will be repealed, meaning their ability to invest in particular types of Australian projects will be improved.
Non-arm's length income rule
A consequence of establishing an attribution MIT is the application of a new non-arm's length income rule. Under this rule, if an attribution MIT derives non-arm's length income under a scheme with another party that is not an attribution MIT, the trustee is liable to pay income tax at the top marginal tax rate plus relevant levies (currently 49%). This is to be contrasted with the MIT withholding tax rate of 15% and the corporate tax rate of 30%.
In practice, this rule may be relevant to an attribution MIT that derives rental income from a related operating company that leases land from the attribution MIT, or an attribution MIT that lends an amount to a related operating company.
A transitional rule will provide that the non-arm's length income rule does not apply to non-arm's length income derived by an attribution MIT before 1 July 2017, if the attribution MIT became a party to a non-arm's length scheme before the date the legislative bill is introduced into the parliament. This may provide taxpayers a transitional period to restructure what are otherwise non-arm's length transactions.
Other changes to be mindful of
The proposed rules also include measures that:
- ensure by way of specific legislative provisions that amounts derived or received by the attribution MIT retain their character when attributed to its unitholders (i.e. a "character flow-through" rule);
- specify the circumstances in which the trustee is liable to tax at the top marginal tax rate (plus relevant levies) (e.g. where the taxable income of the attribution MIT is not fully attributed to its members or is attributed incorrectly, or where an attribution MIT derives non-arm's length income (as discussed above)); and
- clarify the tax treatment of tax deferred distributions made by an attribution MIT to its unitholders (i.e. to reduce cost base of the unitholder's membership interests for unitholders with interests held on capital and revenue account).