Key point: A new Bill would allow managed investment trusts to elect for capital treatment of gains derived from the disposal of certain eligible assets, including shares.

The Federal Government has unveiled the new version of the proposed capital election regime for eligible managed investment trusts (MITs) as part of the Tax Laws Amendment (2010 Measures No. 1) Bill 2010.

The Bill incorporates welcome changes from the Exposure Draft released last December, including a widened definition of MIT that extends the definition to a significant number of trusts.

It also provides greater certainty for Australian investors in the aftermath of events involving the private equity firm TPG and its disposal of Myer shares. In the TPG/Myer action, the Australian Taxation Office is alleging TPG's gains are ordinary income and not capital gains. However, the new MIT rules would allow MITs to elect for capital treatment of gains derived from the disposal of certain eligible assets, including shares, making the CGT discount available to eligible taxpayers.

Proposed rules affecting the taxation of managed investment trusts

The Bill proposes four changes to the current law:

  • introduction of the choice for MITs to elect capital treatment for disposals or realisations of certain assets;
  • extension to the current definition of MIT;
  • ordinary income treatment of distributions and gains with respect to carry interests in MITs (ie. treated as revenue gains); and
  • restriction on the Commissioner to amend prior year tax returns.

Capital treatment of a managed investment trust's disposal of a covered asset

Under the proposed rules, where an effective election is made, capital treatment will apply to a disposal (or other realisation) of a "covered asset" (unless the MIT is a "corporate unit trust" or a "public trading trust" for tax purposes at the time of the disposal or realisation).

Covered assets are:

  • shares in a company (including shares in a foreign hybrid company);
  • a non-share equity interest;
  • units in a trust;
  • land (or an interest in land); and
  • rights or options to acquire or dispose of an asset described above.

Extension to the definition of a managed investment trust

The current definition of MIT is contained in the Taxation Administration Act 1953. The Bill proposes to extend the definition of MIT for the purposes of enabling more entities to make the capital election. Broadly, Australian trusts that do not satisfy the current definition of MIT may still qualify if they are operated or managed by a financial services licensee whose licence covers it providing financial services to wholesale clients (or an authorised representative), and:

  • each member is either a MIT, a life insurance company or a complying superannuation fund; or
  • 75% or more of the interests in the trust are held/controlled by members of the trust that are qualifying entities (including life insurance companies and complying superannuation funds); or
  • the trust has more than 50members (tracing through interests held by trusts is now allowed); or
  • the trust is an exempt Crown entity or exempt under an ASIC instrument.

They can also qualify if every one of their members is a MIT (note, if this requirement is satisfied, the trust is not required to be operated or managed by a financial services licensee).

Taxation of carry interests

With respect to carry interests (ie. interests carrying an entitlement to a distribution from a MIT that is contingent upon the level of profits made by the MIT), the proposed rules treat as assessable income, and deny the availability of the CGT discount on:

  • amounts distributed with respect to a carried interest (except to the extent it represents a return of capital on the interest); or
  • gains arising from a CGT event with respect to the carried interest.

Restriction on prior year amendments by Commissioner

An interesting addition to the Bill is the restriction on the Commissioner from amending prior year assessments of the trustee of, beneficiary of or an entity that holds indirect interests in, a MIT that has made the capital election (unless requested to do so by the taxpayer or where there has been fraud or evasion). In such situations, the Commissioner may not amend with respect to the revenue or capital treatment of a gain or loss in relation to a CGT asset.

What should eligible funds do now?

Fund managers should begin analysing membership of their funds to confirm whether or not they meet the criteria to qualify as a MIT. For funds that currently satisfy the MIT definition (whether under the current rules in the Taxation Administration Act or the proposed rules discussed above), funds should be ready to make the election before the later of:

1.the last day of the 3-month period starting when the new legislation commences;

2.the last day of the fund's 2009-10 income year. This election will be effective from the start of the 2008-09 income year (ie. retrospectively from 1July 2008 for funds with a 30 June year end) through to future income years.

For funds that became a MIT during the 2009-10 (or later) income year, the election must generally be made on or before the day the fund lodges its tax return for the income year in which it became a MIT. This election will be effective from the start of the income year in which the election is made.