INSIGHT

Managed investment trusts exposure draft legislation: impacts on funds management industry

Private Capital Tax

In brief

Exposure draft legislation to implement the long-awaited changes to the tax regime for managed investment trusts has been released. The amendments are lengthy and complicated, and will require systems changes and careful review of trust deeds and constitutions. Although the new regime will apply automatically to MITs that qualify as 'Attribution MITs', Treasury is considering making participation in the new regime elective for existing MITs. Partner Charles Armitage and Managing Associate Judith Taylor outline some important features of the new regime and the likely impacts on the funds management industry.

How does it affect you?

  • Managed investment trusts (MITs) that may be subject to the new stand-alone regime will need to review existing trust deeds and constitutions to determine whether they should be amended to allow trustees and responsible entities to comply with some or all of the requirements of the new regime, and, if so, whether such amendments can be effected without triggering other tax or duty consequences. Some trustees and responsible entities may need to consider seeking the exercise of the Commissioner's discretion to treat an MIT as having clearly defined interests.
  • MITs that meet the qualifying criteria will be subject to the new attribution regime with the consequences that those MITs will:
    • no longer be subject to the present entitlement rules in Division 6 of the Income Tax Assessment Act 1936 (Cth), and instead will be subject to specific attribution rules, under which amounts attributed to unitholders will retain their tax character as they flow through the MIT;
    • be treated as fixed trusts for the purposes of the income tax law; and
    • need to adapt their systems to deal with the new reporting requirements, specific allocations of deductible expenditure to different types of trust income and the new 'unders and overs' correction regime.
  • The proposed start date of 1 July 2015 may prove problematic for trustees and responsible entities but there have been some suggestions that it may be pushed back to 1 July 2016.

Attribution MITs (AMITs)

To qualify for the new regime, MITs must fulfil a new test: the members of the trust must have 'clearly defined interests' at all times when the MIT is in existence in an income year. This test is intended to ensure that only MITs that are sufficiently non-discretionary benefit from the new regime.

The test requires that the entitlement of each member to the income of the MIT can be worked out on a fair and reasonable basis having regard to the constituent documents of the MIT, and the rights of each member to the income and capital of the trust cannot be materially diminished through the exercise of a power or right in the constituent documents. (There are some additional requirements for unregistered trusts which reflect conditions that apply to registered trusts under the Corporations Act.)

In response to suggestions during the consultative process that the 'clearly defined interests' test might be too prescriptive to deal with the range of discretions commonly used in unit trust deeds, the draft legislation contains a discretion for the Commissioner of Taxation. This discretion allows the Commissioner to conclude that the 'clearly defined interests' test is met where the Commissioner considers that it is reasonable to conclude that the rights of each member to the income and capital of the MIT are clearly defined at a particular time, having regard to the constituent documents and any other matter that the Commissioner considers relevant.

Attribution model

Under the attribution regime, amounts attributed to members, such as discount capital gains, foreign-sourced income and amounts that are subject to dividend, interest or royalty withholding tax, will retain their character when attributed to members.

There are 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, these 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. The anti-streaming rules will also not be breached by the allocation of amounts to members based on their membership of the MIT during different parts of the income year.

Trust amounts that are to be attributed to each member are calculated as the relevant income amount, net of expenses that are to be allocated to the particular income amounts in accordance with specific deduction allocation rules. Trustees will be required to determine whether particular deductions relate to particular amounts of income and must maintain a document that records the results of these determinations, which is to be used as the basis for attributing trust amounts to members. These requirements will, in many cases, require either new or more refined internal accounting systems for existing MITs. We query whether trustees could be ready by 1 July 2015.

New documentation requirements

AMITs will be required to issue statements notifying members of the amounts of each particular trust amount being attributed to them and its character within three months of the end of a relevant income year. The approved form of such statements is still being developed by the Commissioner of Taxation, in consultation with key stakeholders.

If variances are discovered after the statements have been issued, the trustee has the choice of revising the statements, which must be done within three years after the end of the income year to which the statement relates or relying upon the new 'unders and overs' system.

The 'unders and overs' system is intended to reduce the compliance burden for AMITs by allowing AMITs to reconcile certain variances in attribution amounts that are below prescribed thresholds and that are discovered in a subsequent income year in that subsequent year, rather than requiring the amendment of issued statements. The 'unders and overs' system is complex and may require significant adaptations to current systems, although, subject to what the proposed transitional rules say, those adaptations may not be required until the 2016-2017 income year.

Further measures for AMITs

Other measures being introduced with the new attribution regime include:

  • the introduction of an arm's length rule under which the trustee of an MIT that derives non-arm's length income will be taxed at the top marginal rate on the excess over the arm's length amount;
  • the introduction of a (limited) ability for AMITs to issue 'debt like' units which are generally treated as debt for tax purposes; and
  • annual cost base adjustments for members' interests in an AMIT up and down, accompanied by a now CGT Event E10. This should address uncertainties as to the treatment under current law of tax deferred distributions.

Other proposed amendments

  • A broadening of the scope of eligible investors for the purpose of the widely held requirements for MITs to include foreign life companies and permit tracing through interposed entities in some cases.
  • A narrowing of the application of Division 6C (public trading trusts taxed like companies) such that superannuation funds and exempt entities are generally excluded from the 20 per cent tracing rule, with the result that trusts will generally not be taxed like companies simply because those types of entities own more than a 20 per cent interest in the trust.
  • The repeal of Division 6B, which taxes 'corporate unit trusts' as companies.

Next steps

The exposure draft legislation will be welcomed by the industry, which has been awaiting changes to the MIT regime for some years.

There is a brief consultation process in relation to the Exposure Draft and submissions are due by 23 April 2015.

In the absence of appropriate transitional provisions, existing MITs need to urgently consider the terms of their current trust deeds and offer documents and assess what changes may need to be made to their systems to deal with the new attribution and 'unders and overs' regimes and the accompanying documentation requirements.