This article was written by Richard Snowden and Amber Hu.
The Minister for Revenue and Financial Services, the Hon Kelly O'Dwyer MP, announced changes to Australia's financial services taxation regimes on 19 July 2017. The changes are aimed at reducing the uncertainty caused by technical issues with the practical operation of the Investment Manager Regime (IMR) and the new tax system for attribution managed investment trusts (AMITs).
The release by the Government of the proposed technical amendments will be welcomed by the industry and underscores the Government's commitment to making Australia a centre for funds management.
Investment Manager Regime (IMR)
The IMR has been in place for a number of years and is proving successful in attracting foreign funds into Australia. Foreign funds that invest via an Australian fund manager may be eligible to access IMR concessions in relation to disposal gains and losses (generally not assessable or deductible on disposal of portfolio interests), and can generally disregard certain Australian income tax consequences (e.g. permanent establishment issues).
The concession relies on the fact that the foreign fund is a non-resident of Australia – however the use of an Australian fund manager raises concerns whether by reason of the activities undertaken in Australia the foreign fund could be exposed to a residency issue. Such concerns have become more topical following the recent High Court decision in Bywater Investments Limited v Commissioner of Taxation. In this regard, other jurisdictions such as the UK had taken measures to avoid this possibility some years ago.
The Government will clarify that when a foreign investor invests in Australia through a foreign fund or an independent Australian fund manager, it will be in the same tax position as if had invest directly. That is, the appointment of an Australian investment manager and the carrying out of the investment functions on behalf of the foreign fund will not give rise to a residency issue.
The Government has noted that it is committed to implementing an effective IMR whilst maintaining the integrity of Australia's residency rules. As such it will consult with industry on whether a legislative amendment is required to ensure that the engaging of an Australian fund manager (and the carrying out of the investment functions on behalf of the foreign fund) will not lead to a fund that is established and controlled offshore to be an Australia resident. It is proposed that any legislative amendment would retrospectively apply from the start of the IMR regime in 2015.
The Government is to be congratulated for acting so quickly in response to industry concerns.
Managed Investment Trusts (MITs) and Attribution Managed Investment Trusts (AMITs)
The Government made major changes to the laws relating to the new tax system for Managed Investment Trusts (MITs) in 2016 with the introduction of the new tax regime for AMITs. The AMIT regime is designed to allow greater flexibility, increase certainty and reduce compliance costs for eligible MITs, thereby enhancing the competitiveness of Australia's funds management industry. However a number of technical issues had arisen which potentially could cause issues in relation to the operation of the regime and potential dissuade or prevent certain MITs electing to become AMITs.
Following industry consultation the Government has agreed to implement various technical amendments which will clarify the operation of the law and remove some barriers to entities seeking to opt into the regime:
- Investors in MITs no longer able to exclude distributions received in relation to Capital Gains Tax (CGT) concession amounts in recalculation of cost base and CGT event E4 gains
The Government has announced that it will amend CGT event E4 for MITs to bring greater alignment in the tax outcomes of MITs and AMITs. This change responds to industry concerns that potential differences in the CGT outcomes for investors in MITs and AMITs may discourage some MITs from electing into the AMIT regime.
Going forward, investors in MITs will be required to adjust the cost base of their units in the MIT when it distributes an amount claimed to be non-assessable (the CGT concession amount) as a consequence of the offset of a capital loss or net capital loss in certain circumstances, meaning that investors in MITs will no longer be able to exclude the distribution they receive in relation to these non-assessable amounts when calculating their cost base and determining CGT event E4 gains.
This change will apply for distributions made in relation to the 2017-18 income year and future income years.
- MITs with substituted accounting periods eligible to opt into the AMIT regime
Currently, a trust can elect into the AMIT regime for income years starting on or after 1 July 2016, or 1 July 2015 (if the trustee chooses early adoption). However, the current rules do not operate as intended for early balancers.
The Government will ensure that an eligible MIT with an income year starting on a date other than 1 July can opt into the AMIT regime from its first full income year starting on or after 1 July 2015.
- Redefining the meaning of fund payment to broadly align the tax outcomes of investing via a MIT with direct investment
The Government will amend the meaning of 'fund payment' to clarify that the fund payment for both MITs and AMITs should be calculated on taxable Australian property (TAP) net capital gains only. The manner in which fund payments and the necessary MIT withholding have been determined under the MIT regime has been a source of some uncertainty where the relevant MIT has foreign unitholders and gains and losses referable to both taxable and non taxable Australian property. As a consequence of the proposed amendments;
- non-TAP capital losses will not be able to be applied against TAP capital gains in working out the determined member components of TAP capital gains for the purposes of calculating the fund payment.
- non-TAP capital losses should not be added back to increase the fund payment amount where they are either offset against non-TAP capital gains or to the extent there are carried forward non-TAP capital losses.
- Carried forward non-TAP capital losses applied in later years against TAP capital gains will be required to be included in the fund payment amount in the later year.
- Carried forward non-TAP capital losses applied in later years against non-TAP capital gains will not be required to be added back to increase the fund payment amount in that later year.
- MIT withholding provisions apply to the amount of the fund payment that is attributed to the taxpayer by an AMIT
There is current uncertainty as to the calculation of the relevant MIT withholding on a fund payment where the fund payment is greater than the cash distributed. The Government has proposed that the MIT withholding provisions will be amended to confirm that they apply to the amount attributed not the cash amount distributed. This should ensure that the non-assessable non-exempt amount is appropriately calculated for ultimate beneficiaries.
- MIT withholding provisions
The Government will clarify that a deemed payment can arise in circumstances where no fund payment is made for an income year to ensure that the withholding MIT provisions apply appropriately to deemed payments. For instance, the application of the tax file number (TFN) withholding to AMITs will be clarified to ensure that the amount of payment (including deemed payments) is calculated appropriately for TFN withholding purposes.
- Meaning of AMIT amended so that single unitholder widely-held entities can access the AMIT regime
Currently a significant constraint is that for a MIT to be an AMIT it is in effect necessary for that MIT to have two members (unless the MIT is itself wholly owned by another MIT). This change will allow a single unitholder widely-held entities to access the AMIT regime. Note it will not extend to allowing single unitholder MITs to be a withholding MIT.
This change will also not extend to including platforms, wraps or master trusts (also known as Investor Directed Portfolio Services) in the list of deemed widely-held entities. However, the Government has indicated that it will consult with industry on broadening the eligibility for these widely-held entities to access the concessional tracing rules as part of the Corporate Collective Investment Vehicle public consultation process.
- Transitional rules regarding franked distributions
Some trusts ceased to be public trading trusts or corporate unit trusts as part of the AMIT reforms in 2016. Transitional rules apply so these trusts can continue to treat distributions from pre-1 July 2016 income as frankable distributions so that they can use accumulated franking credits.
The transitional rules will be clarified so that franking credits of the trust are not cancelled when it ceases to be a corporate unit trust or public trading trust; franking credits cannot be attached to distributions of post-30 June 2016 income; and in the case of a trust that ceases to be a corporate unit trust, the distribution will retain the character of a unit trust dividend when it is paid to a unit holder.
- AMIT Unders and Overs
The Government will amend rounding adjustment and trustee shortfall tax provisions in the income tax law to ensure that the discount capital gains are properly taken into account under the AMIT unders and overs regime.
- CGT Event E 10 (nil starting base)
The Government will clarify that CGT event E10 can happen without the need for a cost base reduction in an income year where the cost base of the asset is nil at the start of that income year.
The amendments are particularly important given that many funds have or are intending to, or elect into the AMIT regime with effect from 1 July 2017. The full press release can be found here.