Managed Investment Trusts – Current Amendments – Feb 2013

March 12, 2013 − by Unity Fund Services − in News

Overview

The Managed Investment Trust (“MIT”) regime is a concessional tax regime that allows eligible Australian funds the following important tax concessions:

  • Concessional withholding tax rates on “fund payments” to foreign investors depending on the residency of the investor;
    • 15% for investors resident in Exchange of Information (“EOI”) countries (see Annexure A);
    • 30% for other non-residents; and
    • 10% withholding tax rate is available to eligible distributions by MITs which only hold certain energy efficient buildings constructed after 1 July 2012.
  • Capital Gains Tax (“CGT”) provisions to apply to taxing gains and losses on the disposal of eligible assets; and
  • In February 2013, the Federal government also announced its intention to amend the MIT rules to clarify that foreign pension funds and sovereign funds can access the MIT withholding tax regime.

In order to access the MIT concessions, there are a number of conditions that must be satisfied being: 

  1. The trust must have a relevant connection to Australia;
  2. The trust must not be a trading trust;
  3. The investment management activities in relation to the trust should be carried out largely in Australia in respect of Australian assets;
  4. The trust must be a managed investment scheme under the Corporations Act 2011 (Cth);
  5. The trust must be widely held;
  6. The trust must not be closely held; (that is, 75% of the interests are held by fewer than 20 persons)
  7. The trust must be operated or managed by a financial services licensee or authorised representative. 

Reduced rate of withholding tax for foreign investors 

The reduced rate of withholding tax applies to fund payments made to foreign investors. Broadly, a fund payment is a distribution of Australian sourced income (for example: net rental income) including gross capital gains on taxable Australian property but excludes dividends, interest and royalties as they continue to be subject to the general withholding tax regime. 

The applicable rate of withholding depends in the residency of the foreign investor. Where the foreign investor is resident in a country that has entered into an EOI agreement, the rate of withholding is 15% and 30% for residents of non EOI countries. 

CGT concession 

The MIT capital account treatment allows eligible MITs to elect to apply the CGT provisions (as opposed to revenue account treatment) on the disposal of eligible assets including: 

  • A share in a company;
  • Non-share equity;
  • A unit in a Unit trust;
  • Land; and
  • A right to acquire an interest in any of the above assets. 

The election must be made in the approved form during the year that a trust qualifies as a MIT. Where an election is not made in that first year, deemed revenue account treatment will apply. The election once made is irrevocable. 

The role of the fund administrator

Fund administrators / fund accountants play an important role in the distribution payment cycle in accurately recording and withholding the appropriate rates. This information needs to be matched accurately to registry records and should be co-ordinated by the fund administrator. 

MIT conditions explained 

The definition of a MIT is core and fundamental to accessing the available concessions. These conditions are discussed below:

1.     The trust must have a relevant connection to Australia

The trustee of the trust must be an Australian resident or the central management and control of the trust must be in Australia. 

2.     The trust must not be a trading trust

A “trading trust” is a trust that is carrying on trading business or controls another entity that is carrying on a trading business. 

A “trading business” is any business that does not consist wholly of “eligible investment business” activities. The legislation contains a list of specific activities that qualify as eligible business investment activities. Broadly, these are passive investment activities such as investing in land for the purposes, or primarily for the purpose of deriving rent and investing or trading in shares, units or other financial instruments. 

3.     The investment management activities in relation to the trust should be carried out largely in Australia in respect of Australian assets

A substantial proportion of the investment management activities in relation to the Australian assets of the trust (as listed below) must be carried out in Australia: 

  • Assets that are situated in Australia at any time in the income year;
  • Assets that taxable Australian property at any time in the income year; and
  • Assets that are shares, units or interests listed for quotation in the official list of an approved Australian stock exchange. 

The focus of this requirement is on the investment decisions (and related activities) of the trust. Such decisions relate to the type of, and timing of the purchase of, investment assets. 

Based on the limited guidance provided, the following activities will constitute investment management activities: 

  • Undertaking market analysis and identification of potential investment and opportunities;
  • Due diligence of potential acquisitions;
  • Providing recommendation on the asset mix of the trust (i.e. buy and sell recommendations); and
  • Undertaking investment decisions (i.e. where to invest). 

In determining whether such decisions are made in Australia or overseas, a substance over form approach for testing should be applied. This means that: 

  • Appointing an Australian investment manager which sub-contracts its role to a non-resident manager will not be acceptable; and
  • appointing a non-resident manager that purports to make decisions in Australia on a fly-in, fly-out basis will also not be acceptable.

The local management test is applied on an annual basis having regard to the services provided in each year of income. Accordingly, if a non-resident entity is involved in the decision associated with the establishment of the trust, the trust may still become a MIT in subsequent years of income if the on-going management of the fund is assumed by an entity in Australia. 

The ATO has provided some guidance in private rulings discussing the investment management requirement. In one particular private ruling, the relevant investment management agreement provided that the trustee would provide, and be responsible for, the day to day management of the trust’s businesses, operations and properties and the investment management activities pertaining to the trust, including real estate investment and business management services. 

The management agreement gave the trustee a very broad authority to conduct the significant majority of the investment and business management activities of the trust. However, the investment management agreement did ensure that the more significant aspects of the trust’s operations required unit holder approval. 

This private ruling suggests that the Investment Manager needs to take a very active role in the management of the trust but notes that the unit holder may approve decisions the trustee has already made (i.e. approve decisions already made rather than the unit holder making the decisions on behalf of the trustee).

4.     Corporations Act requirements

The trust must be a managed investment scheme (“MIS”) within section 9 of the Corporations Act 2001.

This generally requires that the trust has at least 2 members. A trust that has a single member may be treated as an MIT for the purposes of the MIT capital account election rules provided that a single member is a specified widely held entity. Please refer to the discussion in point 5. 

The provisions allow for registered and unregistered MISs to obtain MIT status. In certain circumstances, an unregistered MIS can become a MIT where the entity is a wholesale fund or operated by a Crown entity not subject to registration requirements under the Corporations Act. 

Broadly, retail funds are required to obtain MIS registration (although a wholesale fund can opt to voluntarily register). To obtain this registration, a registered MIS must have a Responsible Entity (“RE”) that operates the scheme. REs must be a registered Australian public company and hold an Australian Financial Services Licence (AFSL) that authorises the operation of a registered managed investment scheme. 

Wholesale funds can choose whether to become registered or remain unregistered. In the instance that the fund remains unregistered, the trust must be operated by an AFSL holder or by an entity that is exempt from holding an AFSL. In this context, the AFSL must cover the provision of financial services to wholesale clients. 

Classifying the entity as a registered or unregistered MIS is relevant for the purposes of determining the requirements that need to be satisfied under the widely-held and closely held tests.   

5.     The trust must be widely held

In order to qualify as a MIT, both registered and unregistered schemes must be widely held. A summary of the membership requirements is as follows:

Type of FundWidely Held requirement
Registered Retail Fund
  • Listed on an Australian stock exchange; or
  • At least 50 members (limited tracing through trusts); or
  • One or more specific “widely held” entities with interest of at least 25% and no other entity with interest of 60% or more.
Registered Wholesale Fund
  • Must have at least 25 members (limited tracing through trusts); or
  • One or more specific “widely held” entities with interest of ≥ 25% and no other entity with interest of ≥ 60%.
Unregistered Wholesale Fund
  • Must have at least 25 members (limited tracing through trusts).

6.     The trust must not be closely held

Type of FundClosely Held test
Retail Fund
  • Where either 20 or fewer persons hold 75% or more of the trust or one foreign resident individual holds an interest of 10% or more.
Wholesale Fund
  • Where either 10 or fewer persons hold 75% or more of the trust or one foreign resident individual holds an interest of 10% or more.

During the start-up and end years, the widely held and closely held requirements are taken to be satisfied:

  • If the trust is created during the 6 months immediately prior to  the start of the income year and ending at the end of the income year;
  • If the trust ceases to exist during the income year and was an MIT in relation to the previous year of income.

This makes the MIT capital account election critical since the election must be made during the first year that a trust qualifies as an MIT. Where an election is not made in that first year, then a deemed revenue treatment applies to certain assets. Accordingly, it is critical to determine if the trust first qualifies as an MIT in its start-up year. The election once made is also irrevocable.

7.     The trust must be operated or managed by a financial services licensee or authorised representative

The license requirement is implicit for registered schemes (that is, retail funds and wholesale funds which are registered schemes) since they must have a trustee that holds an Australian financial services licence under the Corporations Act, 2001.

For wholesale funds that are unregistered schemes, there is a separate and additional requirement in that at the time of the first fund payment the wholesale trust must be operated or managed by a financial services licensee, authorised representative or be a qualifying sovereign fund.

Conclusion

Investments in MITs offer significant tax concessions compared to Australian companies and non MIT trusts. The definition of a MIT is core and fundamental to accessing the MIT concessions.

Please note that this information is intended as a guide only and should not be relied upon as professional advice. You should always seek specific advice in relation to your specific facts and circumstances.

Annexure A – Current list of EOI countries

AnguillaFijiKoreaSaint Kitts & Nevis
Antigua & BarbudaFinlandMacauSaint Vincent & The Grenadines
ArgentinaFranceMalaysiaSan Marino
ArubaGermanyMaltaSingapore
BahamasGibraltarMauritiusSlovakia
BelgiumGuernseyMexicoSouth Africa
BelizeHungaryMonacoSpain
BermudaIndiaNetherlandsSri Lanka
British Virgin IslandsIndonesiaNetherlands AntillesSweden
CanadaIrelandNew ZealandTaipei
Cayman IslandsIsle of ManNorwayThailand
ChinaItalyPapua New GuineaTurks & Caicos Islands
Cook IslandsJapanPolandUnited Kingdom
Czech RepublicJerseyRomaniaUnited States of America
DenmarkKiribatiRussiaVietnam