The Government has released exposure draft (ED) legislation containing the proposed new taxation regime for managed funds in Australia, with a possible elective start date of 1 July 2015.
A. Release of exposure draft legislation for managed funds
The Government has released exposure draft (ED) legislation containing the proposed new taxation regime for managed funds in Australia, with a possible elective start date of 1 July 2015.
The regime will seek to exclude qualifying managed funds from the archaic trust taxation provisions that currently apply. Instead, a new regime will apply to qualifying funds, with specific rules dealing with the tax treatment of the managed fund and members in that fund. These qualifying funds are to be termed Attribution MITs (AMITs)
This bulletin provides a summary of this proposed taxation regime. Pitcher Partners is also hosting a briefing session in Melbourne on 16 April 2015 (please contact us if you would like to register for this session). Further materials and guidance will be provided at that session.
B. Do you need to consider these new rules before 1 July 2015?
The proposed taxation rules have been specifically written for the managed funds industry, in close consultation with the various key industry bodies and stakeholders. Accordingly, the rules are tailored to deal with industry practice in distributing income to members and in calculating the tax liabilities of both the fund and members.
There are a number of significantly positive aspects in the ED which could provide benefits to existing AMITs. For example the regime includes: the new attribution regime for allocating taxable income to members on a fair and reasonable basis; the new cost base rules that will seek to remove double taxation uncertainty for members; the new “under and overs” regime that will provide a legislative code for dealing with errors; and the new fixed trust deeming provision. Furthermore, the new provisions support innovative new funds, such as peer-to-peer funding and multi-class trusts.
While there are positive aspects to the proposed regime, not all managed funds will qualify for the new regime. Furthermore, the new regime will come with certain integrity rules and will likely require a large number of potential trust deed amendments and systems changes (including those of external fund administrators and custodians).
Accordingly, each managed fund should assess the positive and negative aspects of the new regime to determine whether it will be beneficial to seek to apply these rules from the 1 July 2015 start date.
C. When would the fund need to be compliant?
One of the critical questions for a fund, in considering the early election date of 1 July 2015, is the time in which the fund will need to be compliant from both a systems and procedures perspective.
In most cases, where a fund is compliant with the current regime, it is likely that its systems and procedures will only need to be updated and compliant for final distributions to be made for the year ending 30 June 2016. That is, while the new regime will apply to fund payments for 31 December 2015, it is expected that in many cases a funds current system may be able to deal with the treatment of those fund payments for the purpose of the new regime.
That being said, each fund will be different. Accordingly, we would recommend that each fund complete their assessment of the new provisions well in advance of the 31 December 2015 cut-off date, in order to determine (at a high level) whether the fund will seek to take advantage of the proposed optional 1 July 2015 start date.
D. What should be included as part of a preliminary review?
While a preliminary review of each fund will be different, we highlight that there are five key critical aspects that we believe should be considered as part of a preliminary review. If performed correctly, your answers to these five key areas would help to inform the trustee (at a high level) as to whether the fund should be considering an early adoption of the proposed new regime.
Qualification of the fund: The trustee should consider whether the fund may be eligible to apply the new regime (i.e. would be classified as an AMIT). Where the fund is unlikely to satisfy the definition of an AMIT, the trustee should consider whether changes could be made to ensure that the fund will qualify as at the start date of 1 July 2015. The fund should consider the extent of such changes and possible tax implications for making such changes.
Systems and process changes: In order to implement the new regime, a number of new systems and processes will be required for calculating taxable income, documenting calculations, preparing member statements (called AMMA statements), calculating “unders and overs” in accordance with the legislation ( including a requirement to uplift prior year amounts by the shortfall interest charge), and various other items. The trustee should identify all possible systems changes that would need to be implemented and whether it will be possible to make those changes in an appropriate time to be compliant with the new regime. Where systems are maintained by external parties (e.g. the custodian or the fund administrator), it will be critical to determine when those external parties will expect to be compliant with the new regime.
Tax issues addressed by the new regime: The new regime will address a number of potential income tax risks and administrative practices that are applied by many managed funds. The trustee should make an assessment of the issues addressed by the new provisions and whether early adoption of the regime will remove these risks. For example, if the fund has substantial franking credits and has not previously sought a ruling on whether it is a fixed trust, the deemed “fixed trust” treatment of an AMIT may be substantial enough to warrant consideration of an early adoption by the managed fund. Accordingly, the trustee should consider the importance of addressing these issues in the short term.
Applying new favourable provisions in the regime: The new regime will also provide a number of favourable new rules for complying AMIT funds. For example, the new cost base regime will provide favourable cost base uplifts as compared to the current regime (which only allows cost base reductions). Furthermore, the new “under and overs” regime will provide a statutory scheme covering both immaterial and material errors made by a trustee. We believe that the trustee should identify all of the new advantageous provisions contained in package and the importance of these items for the relevant fund.
Applying new unfavourable provisions in the regime: The new regime also contains unfavourable provisions that will apply to AMIT funds. For example, this includes the new arm’s length provision that can tax a trustee at penalty rates of tax on income that is derived by a fund in excess of an arm’s length fee. The trustee should identify all of the new disadvantageous provisions contained in the package and the importance of these items for the relevant fund.
Once the above have been considered by the trustee, the trustee should be in a position to determine the costs and benefits of adopting the new regime and whether it would be beneficial to apply the new regime from 1 July 2015.
E. How can Pitcher Partners help you?
The ED and explanatory material contain over 200 pages of a new (and very complex) set of provisions. Pitcher Partners have been closely involved in the development of these provisions since 2009, being an advisor to the Board of Taxation that originally provided the report to the Assistant Treasurer, as well as being involved in the consultation panel with Treasury throughout the whole period of consultation.
During this time, Pitcher Partners have developed a number of guides and tools for performing a high level review of your fund, including standard templates that demonstrate the application of the proposed new rules (such as an “under and overs” calculation methodology template). We also have created detailed presentation packages that explain the new rules and what it may mean for your managed funds.
Pitcher Partners can therefore assist you, in many ways, in understanding whether your managed funds may qualify for the new regime and what you need to do to ensure that your funds comply with the requirements of the new regime. We will be demonstrating the above in our briefing session on 16 April 2015, which is being held in our Melbourne office. Please contact our office if you have not received an invitation to this event.
F. Summary of the new proposals
This section provides a summary of the new proposals contained in the ED. As the actual provisions and explanatory material exceed 200 pages, this section only contains a high level summary and comments on the proposals. If you require further detail, Pitcher Partners have developed a more detailed guide which will be provided to participants on our 16 April 2015 presentation.
F.1. The ATO’s administrative practices
One of the main aims of the ED is to ensure that existing administrative practices of AMITs are codified and provided the force of law. Accordingly, the current practice of “unders and overs” will become subject to a set of provisions dealing with the treatment of these amounts for AMITs. The ED achieves this outcome and provides for specific rules dealing with almost all of these outstanding issues.
It is therefore expected that the ATO administrative practices will cease to apply once the AMIT legislation comes into effect. Accordingly, if a trustee chooses to remain outside of the AMIT provisions and thus remain subject to the ordinary trust provisions, it is expected that administrative practices will no longer be applied to those trusts on a go-forward basis.
Transitional provisions may allow existing funds to either elect to be an AMIT (if they so qualify) or remain outside of the AMIT provisions and be subject to existing provisions. However, to the extent that the ATO may no longer apply administrative practices to such funds that are not AMITs, there is a compelling reason to seriously consider transitioning existing managed funds into the proposed AMIT provisions for this reason alone.
F.2. Qualifying for the new regime (AMITs)
In order to qualify for the new taxation regime, a fund will need to be a managed investment trust (MIT) as defined and its members will need to have clearly defined rights in the fund.
The definition of a MIT is that used in the capital account election provisions, with minor modifications. For example, the start-up and wind-down phase is being extended to 24 months.
Where the managed fund is a MIT, the fund will only qualify as an Attribution MIT (AMIT) where its members have “clearly defined rights” to income and capital under the trust constituent documents.
The clearly defined rights test must be satisfied at all times when the trust is in existence in the income year.
For managed funds that are registered, the ED only requires two tests to be satisfied under the clearly defined rights test. The first is that the trustee must be in a position to determine a fair and reasonable basis for allocating taxable income to members based on rights under the constituent documents. The second is that the rights of each member to income and capital cannot be materially diminished by the exercise of a power or right. For the majority of registered funds, which are required to comply with section 601FC of the Corporations Act and that also require a distribution of income on a pro-rata basis on an annual basis, it is expected that these two tests will be satisfied.
However, unregistered (wholesale) funds would need to satisfy tests in addition to these two basis requirements. Essentially, the additional tests are based on the requirements contained in section 601FC (which requires members of the same class to be treated fairly and members of different classes equally) and section 601GC (which has restrictions on modifying the trust deed and rights of members) of the Corporations Act. In many cases, unregistered wholesale funds will not always comply with these Corporations Act requirements. This may require modifications to the constituent documents to ensure compliance with these rules. However, care should always be taken to ensure that modifications to the trust deed do not result in inadvertent tax consequences for either the fund or members.
The provisions also include a Commissioner’s discretion, which allows the Commissioner to treat the fund as having clearly defined rights.
We highlight that the requirements of the clearly defined rights provision as contained in the ED is (in our view) still excessive. We believe that the requirements could be further relaxed, especially given that the provision is the gateway into the new AMIT regime. Accordingly, we will be making a submission to request that Treasury consider providing a more appropriate threshold into the gateway test.
F.3. Deemed fixed trust treatment
Where a fund is an AMIT, the members of the fund will be deemed to have a fixed interest in the income and capital of the fund. Accordingly, this test is intended to treat the fund as being a fixed trust, which is critical where the managed fund applies the trust loss provisions (for carry forward revenue losses) and the 45 day holding period rules (for flowing through franking credits to members).
This is a significantly important aspect to the rules, as the Commissioner’s view of the current fixed trust provisions means that there are very few funds that would be considered a fixed trust under the current regime.
While that is said, we highlight that we do not believe that the current drafting of the provision works in the manner as intended. That is, the fixed trust rule for franking credits requires members to have a fixed interest in so much of the corpus as represented by the shares. In effect, many believe that this test requires an interest in the underlying assets rather than in the capital of the fund. If this is the case, then the provision needs to be amended to ensure it operates appropriately. This is a significantly important provision in the new regime and we highlight that it is critical that this is drafted correctly to avoid issues in the future.
F.4. The attribution regime
One of the key reasons why the provisions require members to have “clearly defined rights” is to allow AMITs to apply the new “attribution” regime. Currently managed funds allocate taxable income based on the proportionate share a member has in the income of the trust estate. Under the attribution regime, there will be no requirement to distribute income to members. Instead, a trustee will allocate taxable income on a fair and reasonable basis, based on the member’s rights under the constituent documents. Once the taxable income is allocated to members (under an AMMA statement, see F.11), the member is required to include such amounts as assessable income.
By way of example, a managed fund could accumulate all income for five years and then distribute all accumulated income to members on a pro-rata basis at the end of year five. In this example, having regard to the rights of members to income and capital, the trustee could make a determination that it would be fair and reasonable to attribute the taxable income to members on a pro-rata basis for all of the five income years, even though they do not receive distributions for those years. The trustee would issue an AMMA statement to the member in relation to each income year, outlining the amount of taxable income attributed to each member. This amount would need to be included in the assessable income of the member for the year of attribution.
The attribution regime also has character retention provisions. That is, taxable income components (or trust components) with a specific AMIT character (e.g. interest, dividends, capital gains etc) are deemed to retain their character as if the items had been derived directly by the member.
Furthermore, the attribution regime also allows AMIT character items to be streamed, if such streaming is consistent with the constituent documents. For example, a multi-class fund could provide that Class A is entitled to franked dividends and Class B is entitled to interest income. In this case, it would be fair and reasonable to attribute the taxable franked dividends and franking credits to members of Class A and the taxable interest income to members of Class B. We note, however, that the attribution regime has an anti-streaming rule to ensure that funds do not take advantage of this power.
F.5. The unders and overs regime
The unders and overs regime will seek to codify existing industry practice of carrying errors forward to the subsequent income tax year. This is a critical aspect of the new regime and is by far the most complicated.
As many funds are required to report on their net asset value (NAV) shortly after year end and must also determine distribution entitlements at the same time, distributions of many managed funds are often prone to errors. The main source of errors are typically due to estimations that need to be made at that point in time. Furthermore, where a managed fund receives distributions from other trusts or managed funds, it is often impossible to obtain a breakdown of the tax components of the trust distribution.
The unders and overs regime contains two main aspects. The first is to determine whether the overall error is “material” or “immaterial”. Where the error is material, the provisions require underestimations (or an under) in prior years to be uplifted to compensate the revenue for the error. The uplift is essentially a shortfall interest charge. An over-attribution (or an over) of a tax offset such as a franking credit is treated in the same way. The fund or members are not compensated for material errors going the other way (e.g. on an over-attribution of income in a prior year).
a. The materiality thresholds
Whether a net error is material is determined by considering two separate thresholds. The first threshold is set at 5% of the total of the trust components (or taxable income of the managed fund) for the year of the error, which is termed the base year. The second threshold is set at 0.4% of the net asset value of the fund (as determined by accounting standards) for the base year. Where the net error is lower than one of these thresholds, the net error is considered immaterial.
By way of an example, assume that the total net error for the base year is $100,000. Assume further that the taxable income of the managed fund is equal to $1.5 million and the net asset value of the managed fund is equal to $100 million at the end of the base year. In this example, the materiality thresholds are: (a) $75,000 (i.e. 5% x $1.5M); and (b) $400,000 (i.e. 0.4% x $400M). As $100,000 is less than at least one of these thresholds (i.e. item (b) of $400,000), the net error is deemed to be immaterial. This means that certain errors do not need to apply the uplift to compensate the revenue.
b. The calculation mechanism
The regime contains a prescriptive formula for making under and over adjustments. The formulae differ depending on whether the item is an “income” item, or an “offset” item.
Income AMIT character
Offset AMIT character
Essentially, the first formula, which deals with “income” components commences with the calculation of the total taxable amount for that character. For example, assume that for 30 June 2016, the total interest income (net of expenses) is equal to $100,000. This would be the “basic character amount” for interest income. It then requires an adjustment for prior year unders and overs that have been discovered during the income year. For example, assume that there was an understatement of interest of $10,000 in the prior year. This would be an under and would increase the total amount of interest income of the fund by $10,000. The formula then requires an uplift to be calculated. This is the shortfall interest charge calculated on prior year “under” amount. The uplift does not need to be applied if the net errors are not considered “material” (per the materiality test explained earlier).
The total of all of these adjustments will result in the total amount of the AMIT character that is used for calculating the taxable income of members for the income year. For example, if the AMIT character item is “interest income”, the amount included in the tax return and attributed to members is the amount adjusted by the above formula.
Where the total of all these steps is negative, the result is a “trust component deficit amount”. Essentially, this is akin to saying that the AMIT character item (e.g. interest income) is a negative amount. As negative amounts cannot be attributed through a trust to members, the under and over regime has special rules to deal with these amounts.
The negative amount is first allocated to other income character items on a fair and reasonable basis. Essentially, the negative amount is treated like an expense. The term used for the amount allocated to other classes is the “cross-character allocation amount”. To demonstrate, if the total for franked dividends is negative $15,000 and the only other income class was interest of $100,000, the interest class would have a “cross character allocation amount” equal to $15,000 and would be reduced accordingly (i.e. down to $85,000). Finally, if there are prior year trust component deficits that were not allocated, these amounts are carried forward and allocated in future years. This is known as a “carry forward trust component deficit”.
As can be seen from the above, the methodology is very prescriptive, complicated and may not always accord with how adjustments are made by all fund managers in practice. We expect this to be one aspect that fund managers will need to understand and ensure that errors are dealt with appropriately. However, that being said, due to the prescriptive nature of the methodology, it is something that can be built into standard calculation templates fairly easily.
The second formula applies to tax offsets and is the very similar to the first, however it does not allow a negative amount to be carried forward to future year. Accordingly, if there is a negative relating to franking credits (i.e. due to an over-attribution in a prior year), the trustee is required to pay tax on the negative amount. An exception applies for foreign tax offsets, whereby the amount is instead converted into foreign income and attributed to members.
c. Deliberate unders and overs
Under the ED, the trustee of an AMIT may be subject to a penalty of between 47% and 49% where net variances (i.e. unders or overs) exceed the materiality threshold for a base year, where the amount is due to: (a) an intentional disregard of the taxation law by the AMIT; or (b) recklessness. The ATO intend to require AMITs to report their unders and overs in tax returns on an annual basis. Accordingly, where the amounts are significant, this will result in a risk that this provision could apply to the trustee of the AMIT.
It will therefore be critical for AMITs to ensure that tax calculation methodologies are as accurate as possible and that unders and overs are kept to an absolute minimum. Where unders and overs exist, the trustee should be able to explain the reason for each of those differences and why it is not a result of an intentional disregard of the taxation laws or recklessness in applying those taxation laws.
F.6. The cost base adjustment rules
Where a fund distributes tax free or tax deferred amounts, members are required to reduce the cost base of units under CGT event E4. Where the cost base is reduced to nil, the excess is treated as an assessable capital gain. This CGT event is being replaced by a whole new CGT event (being CGT event E10) which will attempt to overcome significant anomalies in the current law. The methodology of the new provision is very different to the current adjustment provision. Where a managed fund has significant timing differences, the move to CGT event E10 would be a positive aspect of the new regime for the fund.
There is currently significant angst in respect of the application of CGT event E4. To begin with the ATO provided a view in ATOID 2012/63 that meant that the distribution of a timing difference was not always excluded from CGT event E4. Furthermore, ATOID 2011/58 indicated that a tax free distribution (attributable to a discount capital gain) could be assessable as ordinary income to a member. It is broadly understood that the ATO have held that this view applies to ordinary members of managed funds.
Going forward, members of AMITs will not be required to apply CGT event E4. The new rules contained in CGT event E10 will seek to address the two anomalies with CGT event E4, amongst other issues.
Firstly, the rules provide for two adjustments to the cost base of a unit, being an upward adjustment and a downward adjustment. An upward adjustment occurs for taxable income attributed to members (reduced by offsets but increased by the CGT discount). Therefore if a member is attributed $100 of taxable income, their cost base of their units is increased by this amount. A downward adjustment occurs for distributions of money or property. Therefore, if the fund distributes the $100 to the member, their cost base of their units is decreased by this amount. Under this system, there is no need to track the distributions as being either tax free or tax deferred.
Having regard to this cost base adjustment mechanism, CGT event E10 will provide a more equitable adjustment mechanism for members and will a significant improvement to the current system. For example, if a member sells their units cum-distribution, their cost base would have been increased by the previous attribution amount (e.g. $100). Accordingly, the increase in cost base will ensure that the higher disposal price of the units will not trigger an additional capital gain to the member and thus will help to avoid double taxation.
Secondly, the new AMIT provisions are drafted so that distributions of money or property are not to be treated as income of the member (outside of the AMIT provisions). There are some limited exceptions to this rule, for example if the units held by the member are trading stock or subject to the TOFA provisions.
We strongly support the proposed new cost base adjustment provisions. Furthermore, we are unclear why the old CGT event E4 has not simply been replaced with CGT event E10 for all unitholders of all trusts. We believe the mechanism provides appropriate outcomes and should be considered more broadly.
F.7. The withholding tax provisions for an AMIT
The current withholding tax system for managed funds (i.e. for dividends, interest, royalties and fund payments) operates when a distribution is made to non-residents. However, the current withholding tax regime would not be able to cope with an attribution regime, where income is not necessarily distributed in any income year. Accordingly, the new regime contains special withholding tax provisions for AMITs. For example, the special rules can apply where the AMIT is also a withholding MIT under the fund payment rules, or is required to withhold on dividends or interest that is flowed through the AMIT.
The proposed new withholding rules are broadly based on the current regime; however they have been modified to operate in conjunction with the attribution regime.
Where the AMIT attributes income at year end via an AMMA statement, the attribution is deemed to be a payment of an amount for the purpose of the various withholding tax provisions. Where a cash payment is also made (referred to as a parallel payment), the parallel payment is ignored for the provisions. If a cash payment is made in an earlier period, then the withholding tax provisions are applied to the cash payment.
The proposed rules also contain special interaction rules to determine whether the fund payment is made to an entity in an Exchange of Information (EOI) country through a deemed attribution regime. This deeming rule is required in order to determine whether the beneficiary is entitled to a 15% or 30% withholding tax rate on fund payments. Furthermore, the provisions also contain special rules where the AMIT distributes to a custodian. As custodians are required to withhold in such cases, the rules require any withholding tax payable by the custodian to be paid by the AMIT. This is done via a proposed notification system.
F.8. The non-arm’s length income rule
While the ED contains many beneficial rules for managed funds, the package also includes a non-arms length rule. Essentially, where an AMIT derives income that is in excess of an “arm’s length” amount, the excess is treated as being taxable to the trustee at the top marginal rates.
By way of example, assume that a fund leases property to a related entity and charges an excessive rental charge (i.e. $200 instead of $100).
Ordinarily, rental income derived by a managed fund will constitute a fund payment amount and may be subject to 15% withholding tax for non-residents receiving the distribution (i.e. withholding of 15% on $200). However, the non-arm’s length rule would reduce the amount of income of the managed fund to the arm’s length rental income of $100 and thus withholding would be reduced to $15. The excess amount of $100 would then be taxed at 49% to the trustee.
A transitional rule has been included in the ED so that arrangements entered into before introduction of the Bill into Parliament will be excluded in respect of income derived until 30 June 2017.
The non-arm’s length rule was recommended by the Board of Taxation as an integrity measure for stapled structures and for managed funds that own corporate entities. Essentially, the rule is aimed at ensuring that managed funds cannot “strip” profits from a company and convert those amounts into tax preferred distributions (which has been seen in other jurisdictions over the years).
The rule was supposed to be accompanied by a reduction in the scope of the public trading trust provisions. Unfortunately, the previous Government only accepted the integrity measure. Furthermore, and curiously, the proposed provision is only intended to apply to AMITs. Accordingly, this integrity rule may act as a preclusion for many funds in moving to the AMIT regime and is a very important consideration for AMITs, especially those that are stapled together with another entity (or that own interests in other entities that do not breach the public trading trust provisions).
F.9. Trustee taxation
There are limited cases in which a trustee may be taxed under the AMIT provisions. Most of these involve cases where income is not attributed to members of the managed fund. In almost all cases, the trustee can avoid an assessment by fixing errors or attribution amounts. Under the ED, a trust assessment can occur in the following cases:
Non-arms length income derived by the managed fund (see F.6)
Negative offset amounts after applying the under and over regime (see F.4)
The trustee can be taxed on the difference between amounts attributed to members on their AMMA statements (referred to as determined member components) where those amounts are different to the calculated amounts for the member (the member components). To avoid this situation, the ED allows the trustee to (instead) issue members with a new AMMA statement to ensure there are no differences between these amounts.
The trustee can also be taxed on the difference between the calculation of taxable income (i.e. the trust components of the AMIT) as compared to the total of all determined member components (i.e. the amounts attributed to members). Again, to avoid this situation, the ED allows the trustee to (instead) issue members with a new AMMA statement.
The trustee can also be taxed where an under of income or an over of an offset are not properly carried forward to the following income year.
Due to the strict liabilities that could apply to the trustee, it will be critical that all attribution and distribution calculations contain cross-checks to ensure that all amounts have been attributed to members. In many cases, differences will exist simply due to rounding. However, while the provisions do not provide an exception for these types of differences, hopefully the size of rounding errors will be immaterial for most funds considering trustee taxation issues.
F.10. Treatment of debt-like units
The new provisions deem certain units (or interests in the AMIT) to be “debt interests” and returns paid on those units to be “interest” for the purpose of the Act and the withholding provisions. Units (or interests) that are to be included in this new provision are essentially preferred units, where preferred returns are fixed from the outset. The new rules provide an alternative form of hybrid “debt funding” for managed funds.
While this provision is akin to the “preference share” rule contained in the debt / equity provisions, this provision is currently drafted in a far broader manner. For example, the relevant units do not have be redeemed in ten years, do not need to apply a present value test and are not subject to the 150 basis points deduction test. Accordingly, the provision will provide an alternative method of debt financing, being “unit financing”. This can be important in many of the wholesale funds, where external financiers may require residual funding to be provided by way of unit capital.
This new provision will create interesting interactions with other provisions of the Act – for example the TOFA provisions. It will be important to understand whether the timing of the deduction provision (which is linked to “distributions”) will be overridden by the TOFA provisions where the returns paid by the fund are classified as a Division 230 financial arrangement.
F.11. The AMMA statement requirement
The ATO standard distribution statement is to be replaced with a requirement to produce an AMIT member annual statement (AMMA statement). While the requirements are similar, the new AMMA statements will be used for multiple purposes. For example, it will be used to determine whether there are “unders and overs” in a particular year and whether the trustee has fully allocated taxable income to members (i.e. if there is any trustee taxation). As the format of the AMMA statement will be prescribed by the provisions, trustees will be required to update their systems to ensure compliance with the requirements.
The legislation will require AMMA statements to be provided within 3 months of year end. However, where corrections are made by the AMIT, the AMMA can be replaced by a new AMMA statement. The latest AMMA is used for the purposes of the provisions.
An AMMA statement must be made in writing (which can include electronic form). It must state the income year, the date on which the statement is made, the entity receiving the AMMA statement, the AMIT character amounts (i.e. the tax components) attributed to members in the income year, and whether a net cost base adjustment is required by the member. If there is an actual distribution referable to the income year, the AMMA is required to disclose the amount of that distribution.
The current ED also requires the AMMA to disclose whether the actual distribution has been sourced from income or capital. This last requirement is quite strange. Given that the attribution rules and the cost base adjustment rules deliberately do not distinguish between income and capital of an AMIT, this requirement seems onerous and unnecessary. Accordingly, we would be hopeful that this requirement would be removed from the final legislation.
Based on the requirements, it is expected that managed funds that prepare the ATO standard distribution statements will essentially be able to maintain the status quo (i.e. as the current statements essentially disclose all of the items required by an AMMA). However, the ATO standard distribution statements also provide additional information that will no longer be required (i.e. distinguishing between tax free, tax deferred and capital distributions).
Furthermore, where the managed fund continues to distribute 100% of its “income” to members, the reconciliation of each cash distribution to the taxable amounts can still be performed on the AMMA statements (however under an attribution model it will no longer be necessary or a requirement of the AMMA). We would expect that, over time, there will be an increase in “accumulation” funds. Accordingly, industry practice will evolve over time such that distribution statements will not necessarily require a reconciliation between the cash distribution and the taxable amounts.
F.12. Repeal of Division 6B and the 20% test in Division 6C
The ED includes two important amendments. The first is the repeal of Division 6B. The second is the repeal of the 20% exempt distribution rule for Division 6C. These are welcomed changes, especially amongst closely held whole sale funds.
Since 2009, industry have awaited the repeal of these two provisions. These provisions are integrity rules that can treat a managed fund as if it were a company for taxation purposes. In the current taxation climate, there provisions are anomalies and should have been repealed a long time ago. These changes are absolutely necessary and are welcomed. However, as outlined below, the ED is silent on how these provisions work in a transitional sense where a trust has already been taxed as a corporate in prior years (due to the application of these provisions.
Division 6B can apply where a company transfers an asset to a managed fund. Technically speaking, this could occur on an initial subscription of capital in the managed fund. The purpose of Division 6B was to discourage the shift of corporate assets of widely held entities into widely held trusts (i.e. to protect the corporate tax base). Given that Division 6C ring fences activities that can be carried out in a widely held trust (i.e. a public trust can only carry on eligible investment activities), and given the proposed introduction of the arm’s length rule, Division 6B is essentially overkill. It is therefore encouraging that this amendment is included in the ED as it removes unnecessary noise in the background (e.g. in relation to the consideration of this issue for Information Memorandums and PDS documents).
However, transitional issues may arise on the repeal of Division 6B, for example where a managed fund is already being taxed as a company under those provisions. One would expect that Division 6B would continue to apply to such a company, especially where the members and the managed fund have an understanding of the taxation treatment of the entity and where franking credits exist due to the payment of corporate tax by the Division 6B entity. However, the current drafting of the provisions simply repeal the Division with no transitional provisions. It is hopeful that the final draft will provide further legislative clarity around these changes.
Division 6C contains the public trading trust provisions that can treat a trust as a company for income tax purposes. Again, these provisions are aimed at protecting the corporate tax base by preventing widely held trusts from carrying on business (other than investment businesses). The 20% rule was introduced as an integrity rule that prevented “exempt” type entities from owning (collectively) 20% or more of the units in a unit trust. Under Division 6C, such trusts were deemed to be public and thus could fall within the corporate taxation provisions if ineligible activities were carried out by the trust. Superannuation funds are deemed to be exempt type entities under section 102MD. In practice, this issue often arises for wholesale funds where there are only a few members of the managed fund, with one or more of them being superannuation funds. Accordingly, if the activities of the wholesale fund are borderline (e.g. whether land is being held for rent or resale), the wholesale fund could currently inadvertently trip up the public trading trust provisions by having one or more superfunds as members.
The 20% rule was drafted at a time prior to our system allowing for franking credits, including refundable franking credits. It is widely accepted that this provision is no longer necessary where the entity would receive a refund of franking credits. Accordingly, the proposed repeal of this provision is a welcomed change and again will unnecessary eliminate time and resources being used on reviewing the application of this provision for managed funds.
F.13. Transitional provisions
A number of transitional provisions are contained in the ED. Essentially these provisions relate to unders and overs as a managed fund moves in and out of the regime.
On becoming an AMIT, the provisions allow under and over amounts discovered after the entity becomes an AMIT (that are referrable to a period before that time) to be carried into the new AMIT system. Essentially this proposal would avoid the need to correct the prior year returns and distribution statements under the old system.
A similar transitional rule will apply where a managed fund ceases to be defined as an AMIT (e.g. it becomes closely held). Essentially, if an under or over is discovered in a year where the managed fund is no longer an AMIT, the amount can still be carried over to that year and adjusted in that subsequent year (i.e. as an adjustment to taxable income, or as an amount of tax payable by the trustee).
The above provides a practical way of dealing with the transition between an AMIT and a non-AMIT for income years with respect to “unders and overs”.
However, the ED is silent on a number of other transitional issues. For example, the transition from the old cost base rules to the new cost base rules back to the old cost base rules. This can be problematic, especially where the attribution regime is used under the AMIT provisions, with cash being distributed when the managed fund is no longer an AMIT. It is expected that the final legislation may include a number of additional transitional provisions.