INSIGHT

The beginning of the end of the unit trust's monopoly?

By Marc Kemp
Financial Services Funds

In brief

Written by Partners Marc Kemp and Charles Armitage

It is surprising the Federal Government did not make more of its release on 4 June of the Board of Taxation's report on tax arrangements applying to collective investment vehicles. We can only assume that the government was slightly embarrassed that the report, handed to the previous government in 2011, has taken nearly four years to emerge, blinking, into the light. Be that as it may, it is here now, and it makes for interesting reading. If the Board's recommendations are followed, they will change the Australian funds management industry. Put at its most basic, the report recommends nothing less than breaking the near-monopoly that the unit trust has held over collective investment vehicles in Australia.


The Board holds as axiomatic the conclusions in the 2009 Johnson Report that offshore investors are dissuaded from investing in Australian funds because they do not understand unit trusts, and that if they had access to a broader range of collective investment vehicles, Australian fund managers would be better able to compete with offshore fund managers. This premise found support in the interim report of the Murray Inquiry, released in July 2014, which pointed out that Australia's financial sector was the largest sector in the Australian economy in 2012-13, but that financial services exports represent only a small proportion of Australia's trade, accounting for around 4.5 per cent of total trade in services at the end of 2013.

How does the Board propose that this be changed? In essence, by offering additional collective investment vehicles the same tax neutrality as unit trusts, if they exhibit certain collective investment vehicle (or CIV) characteristics. We summarise these vehicles and the proposed CIV characteristics below.

Additional CIVs

Having regard to overseas experience, particularly in Ireland and Luxembourg, the Board recommends that at least three additional vehicles be given CIV status.

Type of vehicle
Description

Corporate CIV

To be modelled on the Luxembourg SICAV (ie an investment company with variable capital). As with open-ended collective investment schemes, the investor is in principle entitled at all times to request the redemption of their units and payment of the redemption amount in cash.

CIVs established as companies will need flexibility to allow investors to withdraw their investments, requiring amendments to the Corporations Act 2001 (Cth) restrictions on redeeming and buying back shares and reducing share capital.

Limited partnership CIV

A partnership managed by a general partner (which has unlimited liability for partnership debts), with passive limited partners (whose liability is limited to their investment in, and commitment to, the partnership).

A common private equity fund structure outside Australia; within Australia its use is generally limited to venture capital funds to take advantage of favourable tax treatment limited to those funds.

Common contractual fund (CCF) CIV

Commonly used in Ireland as a collective investment undertaking, under which investors participate and share in the assets of the undertaking as co-owners by contractual arrangement. The CCF is an unincorporated body, not a separate legal entity. As a result, investors in a CCF are treated as if they directly own a proportionate share of the underlying investments of the CCF, rather than shares or units in an entity which itself owns the underlying investments.

The Irish CCF is established by a management company that is vested with powers for the management of the property of the fund. A CCF will also generally have a custodian in which the property of the CCF is entrusted. Investors in a CCF have their liability limited to the amount of their investments.

The Board did not propose any change to Australia's existing CIVs, including listed investment companies, managed investment trusts or venture capital limited partnerships/early stage venture capital limited partnerships – or to their tax treatment.

When would the additional vehicles enjoy CIV-status?

The Board recommended that a corporate CIV, a limited partnership CIV, or a CCF CIV should enjoy CIV status if it has the following broad characteristics. In general terms, CIV status would confer on it the proposed tax outcomes tabulated below. These characteristics would be familiar to fund managers, investors and advisers, as they are similar to those which apply to managed investment trusts.

  • It is widely held, on a look-through basis.
  • It engages mainly in passive investment activities.
  • It does not carry on a trading business, or control another person that carries on a trading business.
  • Finally, it is an Australian resident and, if it is to have access to the concessional withholding tax rate on fund payments presently available to managed investment trusts, it should have a significant connection with Australia.

Proposed tax outcomes

Type of vehicle
Tax recommendations

Corporate CIV

  • Exempt for tax purposes, with the intention of passing the tax burden on to its shareholders
  • Required to pay dividends to shareholders periodically, with the dividends being equal to a substantial proportion of what would be the taxable income of the corporate CIV
  • Required to have a substituted accounting period of sufficient length to enable it to pay final dividends in respect of that period by 30 June
  • Resident shareholders to be taxable at the time they receive dividends
  • For foreign shareholders, dividends are to be treated as amounts not subject to dividend withholding tax where the dividend comprises foreign income, non-taxable Australian property capital gains or franked dividends, with all other amounts being subject to dividend withholding tax
  • A special rate of dividend withholding tax to apply for dividend payments made to foreign shareholders resident in an information exchange country that produces a tax outcome equivalent to the application of Australia's different treaty withholding tax rates for different types of payments to foreign shareholders
  • Corporate CIVs to have the option to elect deemed CGT treatment, similar to that for managed investment trusts

Limited partnership CIV

  • General partnership tax rules to be applied to provide flow-through taxation for the limited partnership CIV. Limited partnership CIVs to be subject to loss limitation rules similar to those in the foreign hybrid limited partnership regime
  • The final withholding tax on fund payments made by a limited partnership CIV possibly to be aligned with that applying to managed investment trusts
  • Limited partnership CIVs to have an option to elect deemed CGT treatment similar to that introduced into the managed investment trust regime

CCF CIV

  • Should provide tax flow-through treatment
  • Investors in a CCF CIV receive flow-through of character and source similar to investors in an limited partnership CIV, with no need for a cost base at the CIV level as is the case under the managed investment trust regime
  • The profits (income and gains) arising or accruing to a CCF CIV to be treated as rising or accruing to the investor in proportion to the value of the assets beneficially earned by them, as if those profits did not pass through the hands of the CCF CIV
  • Final withholding tax on fund payments possibly to be aligned to that applying to managed investment trusts
  • CCF CIVs to have the option to elect the CGT treatment for its eligible investments

Where to next?

All good things take time. Treasury is consulting with interested parties to refine its response to the recommendations. Given how long it has taken to amend the managed investment trust regime to allow attribution managed investment trusts (a discrete process less complicated, one would think, than introducing a broad-based collective investment vehicle regime with attendant changes to corporate, partnership and tax law), we recommend you not hold your breath. However, we think this reform is important and urge those responsible for its carriage to persevere, not least because, without it, Australia's participation in the Asia region funds passport is unlikely to reap all of the rewards it promises.