Chapter 1

Background to the inquiry

1.1 On 4 February 2016, the Senate referred the provisions of the Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015, the Income Tax Rates Amendment (Managed Investment Trusts) Bill 2015, the Medicare Levy Amendment (Attribution Managed Investment Trusts) Bill 2015 and the Income Tax (Attribution Managed Investment Trusts—Offsets) Bill 2015 to the Economics Legislation Committee for inquiry and report by 10 March 2016.

1.2 This package of bills would introduce a new system for taxing managed investment trusts.

Conduct of the inquiry

1.3 The committee advertised the inquiry on its website and wrote to relevant stakeholders and other interested parties inviting submissions. The committee received 7 submissions, which are listed at Appendix 1. The committee also wrote to the Department of the Treasury which provided the committee with responses to Questions on Notice.

1.4 The committee thanks all those who participated in, and assisted the committee with, the inquiry.

Background

1.5 Managed investment trusts are an important part of Australia's financial services landscape. According to the Assistant Minister to the Treasurer:

As of June 2015, Australia had $2.6 trillion in funds under management, larger than Australia's gross domestic product and the capitalisation of Australia's stock exchange. It is one of the largest pools of managed funds in the world, and contributes jobs to the broader financial and insurance services industry, which employs over 400,000 people in Australia...

Managed investment trusts are used by many Australians. Most of us are investors in managed investment trusts, either directly or indirectly through our superannuation funds.[1]

1.6 The introduction of a new tax system for certain managed investment trusts follows the recommendations made by the Board of Taxation (the Board) in its report on the Review of the Taxation Arrangements Applying to Managed Investment Trusts in August 2009.[2]

1.7 The underlying taxation legislation that currently applies to managed investment trusts relates to trusts more generally.[3] The Board was tasked with providing options for introducing a specific tax regime for managed investment trusts (MITs) which would enable Australia to become the financial services hub of Asia.[4]

1.8 The Board concluded that the current taxation arrangements applying to trusts create a level of complexity and uncertainty for managed investment trusts that is unacceptable for an industry of its significance to the economy. This is primarily the result of the current trust taxation provision in Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) being largely developed at a time before trusts were used in Australia as widely-held, commercially operated, collective investment vehicles.[5]

1.9 In the second reading speech, the Assistant Minster to the Treasurer noted that:

...trust tax rules have not kept pace with the growing use of trusts as collective investment vehicles...

The new rules will ensure that the managed investment funds industry is able to continue to operate through trust structures having regard to the commercial needs of industry, the needs of investors, and the need to ensure appropriate integrity, and minimise compliance and administrative costs.[6]

1.10 EY succinctly explained some of the objectives of the reforms:

The underlying objective of the reforms was to reduce complexity and increase certainty concerning the taxation of Australian widely-held collective investment vehicles and their investors, and to implement reforms which should also minimise compliance costs for both. The objective of the reforms reflects the various industries that utilise widely held trust structures for the efficient conduct of their respective non‑closely held businesses, including in the asset management and broader funds investment industries with asset sectors including equities, bonds and interest-bearing securities, property, infrastructure and private equity.[7]

1.11 The new tax system will significantly improve the operation of the taxation law for managed investment trusts by increasing certainty, allowing greater flexibility and reducing compliance costs. According to the Explanatory Memorandum, these reforms will enhance the competitiveness of Australia's funds management industry.[8]

Key provisions of the bills

1.12 The new tax system for managed investment trusts would apply to a managed trust only if:

the members of a managed trust have clearly defined interests in relation to the income and capital of the trust; and
the trustee of the managed investment trust makes a choice to apply the new tax system.[9]

1.13 Managed investment trusts that choose to apply the new tax system would be known as attribution managed investment trusts (AMITs). Under the new tax system, AMITs would have the following benefits:

the trust will be treated as a fixed trust for income tax purposes;
for income tax purposes, the trust will be able to attribute amounts of taxable income, exempt income, non-assessable non-exempt income, tax offsets and credits to members on a fair and reasonable basis in accordance with their interests as set out in the constituent documents of the trust; and
if a trust discovers a variance between the amounts actually attributed to members for an income year, and the amounts that should have been attributed, the trust will be able to reconcile the variance in the income year that it is discovered by using the 'overs and unders' regime.[10]

1.14 The amendments would also:

make the trustees of AMITs liable to pay tax in some circumstances; and
ensure that the Pay As You Go (PAYG) withholding provisions and the withholding tax liability provisions apply appropriately to AMITs and their members, including members that are custodians.[11]

1.15 The new tax system would provide benefits to members of an AMIT because:

a 'character flow‑through' model will apply to ensure that amounts derived or received by the trust that are attributed to members retain the character they had in the hands of the trustee for income tax purposes;
double taxation that might otherwise arise will be reduced because members will be able to make annual upward and downward adjustments to the cost bases of their interests in the trust; and
the taxation treatment of tax deferred and tax free distributions made by the trust is clarified.[12]

1.16 The amendments would also:

transfer the definition of a managed investment trust from the Tax Administration Act 1953 (TAA 1953) to the Income Tax Administration Act 1997 (ITAA 1997);
exclude superannuation funds and exempt entities that are entitled to a refund of excess imputation credits from the application of the 20 per cent tracing rule for public trading trusts in Division 6C of Part III of the ITAA 1936;
repeal the corporate unit trust rules in Division 6B of Part III of the ITAA 1936; and
introduce an arm's length income rule for managed investment trusts.[13]

1.17 The associated bills would support the introduction of the new tax system for managed investment trusts. That is:

the Income Tax Rates Amendment (Managed Investment Trusts) Bill 2015 would make consequential amendments to the Income Tax Rates Act 1986;
the Medicare Levy Amendment (Attribution Managed Investment Trusts) Bill 2015 would make consequential amendments to the Medicare Levy Act 1986; and
the Income Tax (Attribution Managed Investment Trusts—Offsets) Bill 2015 would impose tax on the trustee of an AMIT in relation to amounts of a character relating to tax offsets in certain circumstances.[14]

Key provisions of the bills

1.18 The Tax Laws Amendment (New Tax System for Managed Investment Trusts) Bill 2015 establishes the new AMIT tax system and contains the key provisions of the reforms.

Eligibility to apply the managed investment trust reforms

1.19 A trust would qualify to be an AMIT, and be eligible to apply the new tax system, if, broadly, the trust is a managed investment trust and the members of the trust have clearly defined interests. Division 276 of the ITAA 1997 would apply to an AMIT and replace the general trust provisions in Division 6 of Part III of the ITAA 1936. If trustees choose to apply the new tax system, the choice is irrevocable and will therefore apply for subsequent income years.[15]

1.20 Debt‑like trust instruments issued by the trust would be treated as debt interests for the purposes of working out whether a managed investment trust qualifies as an AMIT and in applying the attribution model.[16]

1.21 A managed investment trust that is an AMIT would be treated as a fixed trust for the purposes of the income tax law.[17]

The attribution model for managed investment funds

1.22 The trustee of an AMIT must calculate the total of the amounts associated with the various activities of the trust that attract different tax consequences—that is, the trust component for each particular character. The trustee must then determine the amount of the trust components of particular characters and create a document recording those amounts.[18]

1.23 The trustee will work out on a fair and reasonable basis how much of the determined trust component of a particular character should be attributed to each member, and issue an AMIT member annual (AMMA) statement to each member advising them of that amount. The amount that is recognised by a member for income tax purposes in relation to their investment in an AMIT is the determined member component.[19]

Reconciling variances in calculating trust components of particular characters

1.24 If a variance occurs in calculating the trust component of amounts with a particular character, the trustee of an AMIT can revise the determined trust components for the base year to which the variance relates and reissue AMMA statements, or apply the over and unders system to attribute the variance to members in the discovery year by adjusting the trust component of the relevant character in that year.[20]

Trustee liable to pay tax

1.25 The trustee of an AMIT would be liable to pay tax where:

the amount of the determined member component of a particular character that relates to assessable income falls short of the member component of that character;
the amount of the determined member component of a particular character that relates to a tax offset exceeds the member component of that character;
the sum of the determined member components of a particular character that relate to assessable income attributed to members is less than the determined trust component of that character;
unders of a particular character that relate to assessable income are not properly carried forward; or
overs of a particular character that relate to a tax offset are not properly carried forward.[21]

1.26 The trustee of an AMIT would be liable to pay tax on a determined member component that has been attributed to a foreign resident is some circumstances.[22]

Operation of the withholding tax provisions

1.27 An AMIT must withhold an amount from a deemed AMIT dividend, interest or royalties (AMIT DIR) payment that it makes to a member that is a foreign resident. A deemed AMIT DIR payment is the total of the determined member components of dividends, interest and royalties that are attributed to members as shown on the AMMA statements to the extent that it exceeds the total amount of any pre-AMMA actual payments made to those members. If an AMIT makes a deemed AMIT DIR payment, the AMIT must pay the Commissioner of Taxation (the Commissioner) an amount that the trustee would have to withhold if the deemed payment was an actual payment.[23]

1.28 An AMIT must withhold an amount from the deemed fund payment that it makes to an entity whose address, or place for payment, is outside Australia. A deemed AMIT fund payment is the total amount of its Australian sourced determined member components of assessable income (other than dividends, interest and royalties) that is attributed to the members as shown on AMMA statements to the extent that it exceeds the amount of any pre-AMMA actual payments made to those members. If an AMIT makes a deemed fund payment, the AMIT must pay the Commissioner an amount that is equal to the amount that the trustee would have to withhold if the deemed payment was an actual payment. If the fund payment is made to another entity that has a place of payment or address in Australia, the AMIT must make information available to the recipient outlining certain details in relation to the fund payment.[24]

1.29 If a custodian receives a deemed DIR payment from an AMIT, the custodian must withhold an amount from any related later payment to an entity whose address, or place for payment, is outside Australia. If the custodian makes a deemed payment that is attributable to a fund payment to an entity whose address, or place for payment, is outside Australia, the custodian must pay the Commissioner an amount that is equal to the amount that the custodian would have to withhold if the deemed payment was an actual payment. If the custodian makes a deemed DIR payment or deemed fund payment to another entity that has a place of payment or address in Australia, the custodian is required to make information available to the recipient outlining certain details in relation to that later payment.[25]

1.30 If an entity that is not a custodian or a managed investment trust receives an amount of dividends, interest or royalties that is not a deemed payment from an AMIT, the entity must withhold an amount from any related later payment to an entity that is a foreign resident. If an entity makes a payment that is attributable to a fund payment that is a deemed payment to an entity that is a foreign resident, the entity must pay the Commissioner an amount that is equal to the amount that the entity would have to withhold if the deemed payment was an actual payment. If a fund payment is received by the entity, the entity must make information available in relation to the payment when another entity that is an Australian resident becomes entitled to the payment.[26]

Taxation consequences for members

1.31 The determined member component of a particular character flows through an AMIT to its members and retains its character. The determined member component of a particular character is generally the amount recorded on the AMMA statement sent to the member by the AMIT. In limited circumstances, a member can nominate a different determined member component of a particular character.[27]

1.32 The cost base and reduced cost base of membership interests held by the member in an AMIT are adjusted downwards if the member's entitlements from the AMIT exceed the amounts of the determined trust components included in the member's assessable income. This can result in a capital gain arising for a member of a trust under certain circumstances, or a greater capital gain, or reduced capital loss, on the disposal of the membership interests. The cost base and reduced cost base of membership interests are adjusted upwards if a member's entitlements from the AMIT are less than the amounts of the determined trust components included in the member's assessable income. This can result in a reduced capital gain, or greater capital loss, on the disposal of the membership interests.[28]

1.33 The tax deferred and tax free distributions made by an AMIT to a member will be applied to reduce the cost bases of the membership interests that are CGT assets, and reduce the tax costs of membership interests that are revenue assets.[29]

Definition of a managed investment trust

1.34 A managed investment trust would be defined in the ITAA 1997, with modifications to:

extend the start‑up period during which a trust does not need to meet the widely‑held and not closely‑held requirements to qualify as a managed investment trust;
modify the widely held requirements so that an eligible investor in a managed investment trust includes: a foreign life insurance company regulated under foreign law; a limited partnership, if at least 95 per cent of its membership interests are widely held throughout the income year, directly or indirectly by eligible investors and the remaining membership interests are beneficially owned 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 an entity that is an eligible investor, or two or more entities that are eligible investors;
clarify the operation of the rule that allows a trust to be treated as a managed investment trust in some circumstances where the only members of the trust are entities that qualify as eligible investors in a managed investment trust; and
clarify the operation of the rule that applies to extend the definition of a managed investment trust where no fund payment is made in relation to an income year.[30]

Transitional arrangements

1.35 Transitional rules would apply when an existing managed investment trust comes into the new tax system to recognise unders and overs that arise from an earlier income year.[31]

1.36 Transitional rules would also ensure the amendments which clarify the taxation treatment of tax deferred and tax free distributions would apply on or after 1 July 2011.[32]

1.37 The amendments which extend the list of entities qualifying as eligible investors for the purposes of the widely held requirements that must be satisfied for a trust to qualify as a managed investment trust would apply from 1 July 2014.[33]

1.38 The amendments that repeal the corporate unit trust rules and modify the operation of the 20 per cent tracing rule for public trading trusts apply on or after 1 July 2016.[34]

Commencement

1.39 The new tax system for managed investment trusts applies to assessments for an income year starting on or after 1 July 2016. The trustee of a managed investment trust will be able to make an irrevocable choice to apply the new tax system for the 2015‑16 income year in some circumstances.[35]

Scrutiny of bills and compatibility with human rights

1.40 The Standing Committee for the Scrutiny of Bills had no comments relating to the package of bills for the new tax system for AMITs.[36]

1.41 The package of bills is compatible with human rights as it does not raise any human rights issues.[37]

Financial impact

1.42 The measure to introduce a new tax system for managed investment trusts is expected to increase government revenue by $5 million in 2016–17, $50 million in 2017–18 and $70 million in 2018–19.[38]

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