Written by Partner Marc Kemp and Senior Tax Counsel Judith Taylor
It has taken a while, but out of the dust of an early Federal Budget and double-dissolution election announcement, a new tax attribution regime for 'Attribution Managed Investment Trusts' (AMITs) has emerged relatively intact. Here is a summary.
The laws giving rise to the new tax attribution regime and a new arm's length rule for managed investment trusts (MITs) received Royal Assent on 5 May 2016.
The new attribution regime will apply to assessments for income years starting on or after 1 July 2016, although trustees of qualifying funds will be able to make an irrevocable choice to apply the new tax system from 1 July 2015, if a relevant trust's income year starts on or after 1 July 2015 (though it remains to be seen if this retrospective application is available to trusts whose deeds need to be amended to qualify for the regime).
The new arm's length rule, which applies to all MITs, not just AMITs, will also apply from 1 July 2016, or a date on or after 1 July 2015 if a trustee has made the choice to apply the AMIT rules to a trust from that date. However, a transitional provision applies to arrangements entered into before 3 December 2015 (which was the date that the amending Bill was introduced into the House of Representatives) which provides that any income from such a pre-existing arrangement derived prior to the commencement of the 2018-19 income year will not be subject to the new arm's length rule.
The AMIT rules are only relevant to trustees of MITs or trusts that may become MITs because it is a threshold requirement for an AMIT that it be a MIT as defined in the newly agglomerated and amended definition of 'managed investment trust' in section 275-10 of the Income Tax Assessment Act 1997 (Cth).
The amendments to the definition include modifying the widely-held requirements so that eligible investors in MITs can include (in changes that will be welcomed):
- foreign life insurance companies regulated under a foreign law;
- limited partnerships where at least 95 per cent of the membership interests are directly or indirectly held throughout the income year by eligible investors with the remaining interest being held by a general partner that habitually exercises the management power of the limited partnership; and
- an entity that is directly or indirectly a wholly-owned subsidiary of entities that are eligible investors.
Also relevant to the new MIT definition is the narrowing of the application of Division 6C of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) (public trading trusts taxed like companies) such that superannuation funds are generally excluded from the 20 per cent tracing rule with the result that a trust will generally not be taxed like a company and will not be a 'trading trust' for the purposes of the MIT definition simply because those types of entities own more than a 20 per cent interest in the trust.
The underlying premise of the AMIT regime is that beneficiaries are taxed on allocated tax amounts with particular tax characters, not cash distributed or trust law income. In this way, tax amounts attributed to members, such as discount capital gains, foreign sourced income, amounts that are subject to dividend, interest or royalty withholding tax and tax offsets, will retain their character when attributed to members.
Although the AMIT rules may require adjustments to systems and procedures, we expect that many trustees will be relieved to no longer have to deal with the issues of 'present entitlement' and 'trust law income' versus 'accounting income' versus 'net income' for tax purposes that arise in the context of applying Division 6 of the 1936 Act and have been the subject of numerous tax cases.
The AMIT regime contains anti-avoidance measures to prevent the streaming of particular amounts with particular tax characters to particular members because of the tax characteristics of those members. However, the rules may permit the effective streaming of a capital gain to a particular member in the event of a redemption of the units of that member and the anti-streaming rules should not be breached by the allocation of amounts to members of different classes based on the different rights attaching to their membership interests in the MIT.
There are a number of reasons why trustees may wish to make an AMIT election, including:
- the clarity and certainty associated with the allocation of tax amounts to unit holders, in contrast to the 'present entitlement' regime in Division 6 of the 1936 Act;
- the sanctioned reconciling of 'unders' and 'overs' in the years in which they are discovered by a trustee, as opposed to the existing law which requires that trustees amend previous years' tax returns and notify the relevant beneficiaries of those amendments;
- deemed 'fixed trust' status and beneficiaries being treated as having vested and indefeasible interests in the income and capital of the AMIT throughout the income year. This will generally make it easier for AMITs to satisfy:
- the trust loss rules requirements for carrying forward trust losses;
- the franking credit rules which allow a trustee to distribute franking credits; and
- eligibility for CGT scrip-for-scrip rollover relief;
- trustees may be able to get creative in the development of different classes with different rights within a single fund; or
- more fair cost base adjustments for members' interests, with both up and down adjustments, and the addressing of some of the uncertainties concerning the treatment of tax deferred distributions.
In addition to being a MIT and the trustee having made the choice to be an AMIT, for a MIT to be an AMIT, the rights to income and capital arising from each of the membership interests in the trust must be 'clearly defined' at all times when the MIT is in existence in the income year. The Explanatory Memorandum to Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2016 (the EM Bill) states that a member's rights to income and capital will be 'clearly defined' if, among other things, the amounts attributed to the member can be worked out on a fair and reasonable basis. However, this does not negate the need for trust deeds to provide for an objective basis for determining the allocations of tax amounts: It is not sufficient to simply provide in the deed for the trustee to make the allocations on a 'fair and reasonable' basis.
A member's interests are automatically treated as being 'clearly defined' if an MIT is registered under Corporations Act 2001 (Cth) or its rights to income and capital arising from each of the membership interests in the trust are the same. However, when drafting or amending an existing constitution for a registered MIT, consideration needs to be given to including fall-back 'clearly defined rights' provisions which are to apply in the event that the MIT ceases to be registered in the future.
Similarly, when drafting or amending an existing constitution for any MIT, consideration needs to be given to including, or leaving in existing, present entitlement clauses where there is a risk that the AMIT may cease to be a MIT in the future, for example, because of changes in its ownership or in the business activities undertaken by the trust.
The new 'unders and 'overs' regime will mean that certain beneficiaries in current and prior income years may benefit from, or suffer loss as a consequence of, errors made in calculating the tax amounts for allocation by a trustee in any particular income year, albeit that such benefits and detriments may not be substantial. It is, therefore, important that beneficiaries understand this particular implication of a trustee making the choice for a MIT to be an AMIT.
Trustees will need to consider the terms of the relevant trust deed and (in the case of a registered scheme) the requirements in the Corporations Act for amending the deed. Many deeds (and the Corporations Act) require unitholder approval (typically by special resolution) if the change will adversely affect the rights of unitholders. That is a sensitive tripwire, and trustees (and responsible entities) will need to consider carefully the effect of any proposed amendments, and not assume that they can be made unilaterally without unitholder approval.
The new arm's length anti-avoidance rule will permit the Commissioner to tax 'non-arm's length income' received by a MIT and will apply to all MITs, irrespective of whether they qualify as AMITS. The rule is aimed at transactions between stapled corporate and trust entities, but could apply more generally than that.
The EM Bill explained that the new rule 'removes the incentive for an attribution MIT to shift profits from an active business of a related party by engaging in non-arm's length activities'. The rule will operate to subject the amount of any 'non-arm's length income' (after subtracting relevant deductions) to tax in the hands of a trustee at the corporate rate of 30 per cent, with adjustments being made to the amounts of trust income upon which beneficiaries are taxable, and subjecting the trustee to further administrative penalties.
In broad terms, an amount of income will be taken to be 'non-arm's length income' if:
- it is derived from a scheme the parties to which were not dealing with each other at arm's length; and
- the amount is more than the amount that the MIT might have been expected to receive if those parties had been dealing with each other at arm's length in relation to the scheme.
There is a specific 'safe harbour' for returns on debt interests where the rate of return on an interest (expressed on an annual basis) does not exceed certain benchmark rates of return.
While the AMIT regime should generally be welcomed as a positive thing for MITs in terms of certainty and flexibility, it remains to be seen whether it will achieve another of its original aims of greater simplicity in the administration of the tax affairs of MITs. Hopefully, this will become clear as part of the proposed post-implementation review over the next two years and any significant practical issues will be able to be rectified in due course.