The Government released and introduced into Parliament on 2 June the Tax Laws Amendment (2011 Measures No. 5) Bill 2010 (“Bill”), which contains, amongst other things, the much anticipated amendments to the taxation of trusts.

Who does this affect?

All fund managers and investors that manage or invest in trusts of any kind.

What do you need to do?

  • Managers of trusts that are “Managed Investment Trusts” must review the changes carefully and decide whether to elect into the new regime while the MIT regime is being dveloped;
  • Determine whether any “streaming” provisions in trust deeds will operate as intended under the new regime and their existing procedures are sufficient under the new regime;
  • Managers of trusts which are not MITs may need to consider amendments to their deeds if they may have unit holders who are tax exempt and subject to the rules.  

New provisions are welcome - the release and introduction of the Bill into Parliament is a welcome development. It provides a specific legislative framework for the streaming of capital gains and franked dividends. The amendments should provide greater certainty regarding the income allocation mechanisms that are currently undertaken by a number of fund managers.

There are some important differences regarding the streaming mechanism that was provided for under the earlier Exposure Draft of these amendments that was released.

MITs have a choice - MITs will have a choice of whether they wish the new provisions to apply for the 2010/2011 and the 2011/2012 income years. That is, prior to the introduction of the proposed new “attribution” regime for the taxation of MITs.

It will be crucial for managers of MITs to review the proposed amendments and determine whether to make the election. Managers should also consider if their existing deeds and procedures are sufficient for the more prescriptive requirements of the new regime in the lead up to year end.

Non MITs need to consider impact of exempt unitholders in fund - the Bill also contains a targeted anti-avoidance rule that applies to trusts with tax exempt beneficiaries. This rule is still fairly broad. However, the current formation of this proposed rule is more appropriately limited.

One of the most important — and welcome — aspects of the Bill is the exclusion from this anti-avoidance rule for trusts that qualify as “Managed Investment Trusts” or MITs under the existing law, but, the anti-avoidance rule remains a concern for non MITs.

A copy of the Bill and the associated Explanatory Memorandum is available here. A copy of our alert which outlined the earlier Exposure Draft (“ED”) of these amendments is available here.

Summary of the proposed amendments and differences from the Exposure Draft

Streaming of capital gains and franked dividends

The proposed amendments should generally not affect the taxation of trusts unless the trust:

  • seeks to “stream” different categories of income for tax purposes to different beneficiaries, or
  • has different income and capital beneficiaries.

The proposed amendments do not seek to alter how trusts are taxed more generally. They create a separate and specific mechanism for the flow through of capital gains and franked dividends (including franking credits) through trusts.

The proposed amendments seek to allow streaming of capital gains and franked dividends where beneficiaries of the trust are “specifically entitled” to capital gains or franked dividends. Whether and the extent to which a beneficiary of a trust is “specifically entitled” is determined under the prescriptive rules contained in the Bill.

An important difference between the current Bill and the previous Exposure Draft are the provisions that deal with when a beneficiary is “specifically entitled” to a capital gain or franked dividend.

Under the previous Exposure Draft, this was defined broadly and provided for beneficiaries to be “specifically entitled” where they were entitled to assets of the trust that represented particular amounts of capital gains or franked dividends. Under the Bill, a more prescriptive process is provided for, where a beneficiary is “specifically entitled” based on their proportionate entitlement to “net financial benefits” from the trust representing the capital gain or franked dividend.

The Bill also contains amendments, consistent with the previous Exposure Draft, to allow the trustee or capital beneficiaries to be taxed on the capital gains of the trust following the withdrawal following Bamford of the Commissioner’s Practice Statement (PS LA 2005/1 (GA)) that previously provided for this.

Anti-avoidance rule for exempt beneficiaries

The Bill, consistent with the previous Exposure Draft, contains anti-avoidance rules that require distributions of income to exempt beneficiaries to be reported; and deems trustees to be taxable in situations where the amount actually distributed to an exempt beneficiary falls short of the taxable income of the trust on which the exempt beneficiary is assessed.

These rules raised significant concern in the funds management industry as a result of the significant investments that had been made by Australian government and other exempt entities in the managed funds industry through trusts.

These concerns appear to have been addressed in the Bill for MITs as the exempt beneficiaries subject to the rule now excludes “Australian government agencies”.

Trusts that are MITs are not subject to this rule. This is the case regardless of whether they elect for the rest of the proposed amendments in the Bill to apply to them.

Trusts which not MITs may need to consider changes to their deeds to ensure adverse consequences do not arise for their unit holders. These consequences can arise if the trustee is taxed by virtue of the new regime.

Application of the proposed amendments

The proposed amendments in the Bill are expressed to generally apply from the 2010-2011 income year and future years. There are some transitional provisions for “early balancer” trusts, that is, those trusts with a year end other than 30 June.

MITs will have a choice regarding whether they wish the general amendments to the rules relating to the flow through of capital gains and franked dividends to apply to them for the 2010-2011 and 2011-2012 income years. This on the basis that the proposed new regime for the taxation of MITs should apply for the income years after that.

Any such choice made by an MIT will apply for both the 2010-2011 and 2011-2012 income years. À MIT cannot choose for the amendments to only apply to one of the two years.

The deadline for the making of the choice is the later of the end of the relevant year of income, and two months from the commencement of the proposed amendments.

Important action items

It is therefore essential for those MITs for which the flow through of capital gains and dividends is a concern to review the proposed amendments carefully to assess whether an election under the proposed amendments should be made.

This should also involve a review of the existing deed, and the procedures particularly for allocation of losses and expenses in determining the amounts to streamed and for the record keeping processes undertaken by the trusts.

For non-MITs it will be important to determine if the current or proposed unit holders may include tax exempt entities. If the fund is to have tax exempt entities as unit holders it may be necessary to make amendments to the deeds to accommodate the anti-avoidance rules. This is to ensure that these are not unintended adverse consequences for other unit holders.