In mid-2008, the Australian Government introduced a new withholding tax regime applicable to certain distributions paid to foreign investors from an Australian ‘managed investment trust’ (MIT), which should present an attractive tax-effective opportunity for real estate, private equity and infrastructure investments in Australia.
Under the regime, the applicable withholding tax rate has been progressively reduced from a 30% tax rate applicable prior to 1 July 2008 to a 7.5% final withholding tax rate applicable to distributions in respect of income years from 1 July 2010. As long as the MIT meets the usual requirements to maintain its flow-through status, there is no additional Australian taxation of the MIT at the entity level.
This tax ‘gateway’ applies to distributions of Australian-sourced net income (i.e. ‘fund payments’) from MITs to certain non-resident investors (see below). The reduced withholding tax does not apply to distributions from MITs that are not ‘fund payments’, such as distributions sourced from dividends, interest (e.g. interest income or amounts paid in the nature of interest, such as a discount on a security) or royalties, which are subject to separate withholding tax arrangements and a reduced rate of tax withholding or exemption may still apply to such amounts e.g. no withholding tax applies in respect of franked dividends. In light of this, the reduced MIT withholding tax arrangements are likely to be of primary benefit in relation to investments in Australian real estate, private equity and infrastructure.
In determining the amount of the ‘fund payment’ to which the reduced withholding tax applies in the relevant income year, any capital gain (or capital loss) that happens in relation to an asset that is not taxable Australian property and amounts that are not from an Australian source are excluded.
For the reduced withholding tax to apply to an investor, the investor must be resident in an ‘information exchange country’, which includes (among others) the Argentina, Bermuda, Canada, China, Czech Republic, Denmark, Finland, France, Germany, Hungary, India, Ireland, Italy, Japan, Malta, Netherlands, Norway, Poland, Romania, Russia, Slovakia, Spain, Sweden, United Kingdom and the United States.
A ‘fund payment’ made to an investor that is resident in a country that does not have an information exchange agreement with Australia will continue to be subject to a 30% withholding tax rate.
To take advantage of the reduced withholding tax rate, the trust must be a MIT as that term is defined in the Taxation Administration Act. This definition requires that it be:
- structured as an Australian-domiciled unit trust (i.e. the trustee must be an Australian resident or the central management and control of the trust must be in Australia); and
- ‘managed investment scheme’ registered with the Australian Securities and Investments Commission (ASIC) (whether it needs to be registered has attracted debate, although the Australian Taxation Office (ATO), in an Interpretative Decision on 4 December 2009, expressed the view that it needs to be registered) - the trustee of the trust would need to hold an Australian financial services licence to operate the registered scheme as ‘responsible entity’ and apply to ASIC for registration of the trust as a ‘managed investment scheme’; and
- listed on an approved stock exchange in Australia or ‘widely held’ i.e. it must have at least 50 members itself or a member of the trust must be a specified ‘widely held’ entity, such as a complying superannuation fund or a foreign superannuation fund with at least 50 members, a life insurance company, a foreign collective investment scheme (with similar status to a managed investment scheme) with at least 50 members or another MIT (including indirectly as part of a ‘chain of trusts’ where each trust in the chain satisfies the MIT requirements).
The ‘tracing’ rules which apply in determining whether a trust is ‘widely held’ should allow for many unlisted trusts to take advantage of the reduced withholding tax rate (assuming they satisfy the other requirements).
The listed / ‘widely held’ requirement will not be satisfied in respect of any income year if a foreign resident individual, directly or indirectly: (i) held (or had the right to acquire) interests representing 10% or more of the value of the interests in the trust; (ii) had the control of (or the ability to control) 10% or more of the rights attaching to membership interests in the trust; or (iii) had the right to receive 10% or more of any distribution of income that the trustee may make.
On 10 February 2010, the Assistant Treasurer also announced a proposed expansion of the definition of a MIT applicable to the withholding tax rules (to ensure closer alignment with the extended definition of that term in the capital account reforms discussed below). In particular, it is proposed that the definition of MIT in relation to the withholding tax rules will be extended to include many types of wholesale managed investment schemes and government-owned managed investment schemes, subject to appropriate integrity rules. In addition, the changes will potentially introduce a ‘trading business test’ for trusts that would otherwise qualify as a MIT and clarify the operation of the MIT definition where there is only one member. Legislation to implement these announced changes is yet to be introduced.