House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan MP

Chapter 5 - Definition of a managed investment trust

Outline of chapter

5.1 Schedule 5 to this Bill makes amendments to Subdivision 12-H of Schedule 1 to the Taxation Administration Act 1953 ( TAA 1953) which applies for withholding tax purposes.

5.2 This Schedule:

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amends Subdivision 12-H of Schedule 1 to the TAA 1953 dealing with the definition of a 'managed investment trust' (MIT); and

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makes consequential amendments to Division 275 of the Income Tax Assessment Act 1997 ( ITAA 1997).

5.3 All legislative references are to Schedule 1 to the TAA 1953 unless otherwise stated.

Context of amendments

5.4 The MIT withholding tax rules were enacted by Subdivision 12-H of Schedule 1 to the TAA 1953. The rules were enacted by the Tax Laws Amendment (Election Commitments No. 1) Act 2008.

5.5 These rules specify the definition of a MIT for the purpose of pay as you go (PAYG) withholding on certain fund payments to foreign residents.

5.6 The intention of the MIT withholding tax regime - to enhance the competitiveness of the Australian managed funds industry in attracting future foreign investment - is achieved by subjecting most foreign investors to a reduced rate of final withholding tax (currently 15 per cent) on fund payments from the MIT. This rate will fall to a 7.5 per cent final withholding tax for fund payments in respect of the income year beginning on or after 1 July 2010.

5.7 The reduced withholding tax rates only apply where the investor is a resident of a country with which Australia has effective exchange of information on taxation matters. In other cases, the rate is 30 per cent.

5.8 Dividends, royalties and interest payments are specifically excluded from being fund payments. Implicitly, fund payments are other Australian sourced income derived from passive investments.

5.9 The Government announced amendments to the definition of a MIT in the Assistant Treasurer's Media Release No. 020 of 10 February 2010. On that day, the Government introduced amendments to the ITAA 1997 to provide for a capital account election mechanism for trusts that are MITs (the MIT capital measure). For the purpose of the capital measure, a trust that is a MIT (as defined in the TAA 1953) is a MIT for capital account treatment.

5.10 The current definition of a MIT for withholding tax purposes precludes some wholesale funds from being treated as a MIT. Provided genuine wholesale funds are subject to regulation in Australia and are appropriately widely held, it is appropriate for these trusts to be MITs for withholding tax purposes and for their foreign resident investors to receive the benefit of the reduced withholding tax rates.

5.11 The Government, in furthering its objective to secure Australia's position as a financial services centre, is amending the definition of a MIT to ensure that certain widely held wholesale managed investment schemes (MISs) and government-owned MISs, are able to qualify as MITs under new rules applying to these funds.

5.12 In addition, new rules will apply to ensure the MIT withholding tax rules are operating as originally intended. The first new rule is the introduction of a trading business test to ensure that Australian active businesses (operating through any structure) are not at a competitive disadvantage. This is also consistent with the policy basis that the MIT definition is aimed at covering only collective investment vehicles that predominantly undertake passive investment.

5.13 Secondly, in line with ensuring the provisions are operating as originally intended, the MIT definition will be limited to qualifying trusts where the investment management activities in relation to the trust are carried out in Australia. The focus of this test is on the investment decisions (and related activities) that are generally undertaken by the manager of the fund. Such decisions relate to the type of, and timing of the purchase of, investment assets.

5.14 This change is designed to ensure that one of the original objectives of the MIT withholding rules - to enhance the competitiveness of the Australian funds management industry - is met. As this policy objective is not as relevant for the MIT capital measure (which is directed more towards increasing certainty for investors and managed funds), this rule will not apply for the purposes of that measure.

5.15 Thirdly, consistent with the objective of both the MIT withholding tax rules and the MIT capital measure, a further change will ensure only genuinely widely held trusts are able to qualify as a MIT. This will be achieved through introducing an exclusion for closely held trusts.

Summary of new law

5.16 Schedule 5 makes amendments to the definition of a MIT for withholding tax purposes. A MIT, as defined in subsection 995-1(1) of the ITAA 1997, has the meaning given by section 12-400. The amended definition will also apply for the purposes of the rules dealing with deemed capital account treatment for MITs in Division 275 of the ITAA 1997.

5.17 These amendments extend the definition of a MIT to allow certain MISs that are not required to be registered under the Corporations Act 2001 because they provide financial services to wholesale clients (unregistered wholesale funds) to qualify as a MIT, provided other requirements to be a MIT are satisfied.

5.18 The amendments also extend the definition of a MIT to allow a MIS that is unable to register under the Corporations Act 2001 because it is operated by an entity in the capacity of the Crown (government-owned), to qualify as a MIT. Likewise, a wholesale MIS that is operated or managed by an entity that is not required to be a financial services licensee because it is an entity in the capacity of the Crown may qualify as a MIT. The amendments will extend to cases where a MIS is operated or managed by an entity that is a wholly-owned subsidiary of a Crown entity and the Australian Securities and Investments Commission (ASIC) has issued an exemption instrument that has effect in relation to the entity and the operation of the MIS.

5.19 These amendments set out a new definition of MIT for both registered MISs (those registered under the Corporations Act 2001 generally operated by a financial services licensee (as defined by section 761A of that Act) whose licence covers operating such a MIS) and unregistered MISs.

5.20 In the case of both registered MISs and unregistered wholesale MISs, the definition of a MIT is being amended to provide that, subject to satisfying other conditions, the trust must be:

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an Australian resident trust;

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a MIS (as defined by section 9 of the Corporations Act 2001); and

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widely held.

5.21 These amendments introduce separate tests to determine whether a trust is widely held in the case of unregistered wholesale and registered MISs. Having a separate widely held test for each type of MIS is appropriate because holdings in each type of MIS, including direct and indirect holdings, are generally quite different.

5.22 Under the current law, a registered MIS may have qualified as 'widely held' (and therefore been able to qualify as a MIT) because of the rule dealing with membership held by a specified widely held entity (in subsection 12-400(2) of the current law). This rule is being repealed by amendments made in this Schedule and, consequently, such a registered MIS will no longer be considered widely held. However this is subject to a transitional rule (discussed in paragraph 5.28).

5.23 Further new rules will ensure the intended objectives of the MIT withholding tax rules, when originally introduced, are satisfied. A unit trust that would otherwise qualify as a MIT will no longer qualify if it is a trading trust for the purposes of Division 6C in Part III of the Income Tax Assessment Act 1936 ( ITAA 1936). Any other trust will no longer qualify if, in the year of income, the trust carried on a trading business or controlled (or was able to control) directly or indirectly the affairs or operations of another person in respect of the carrying on by that other person of a trading business (within the meaning of Division 6C).

5.24 The effect of these additional requirements is to broaden the current exclusion that applies to public trading trusts and corporate unit trusts to all trading trusts.

5.25 Consistent with the original policy objectives underpinning the MIT withholding tax rules - to support the Australian funds management industry - the amendments provide that the investment management activities carried out throughout the income year in relation to the trust must be carried out in Australia. If this additional requirement is not met, the trust will not qualify as a MIT for the withholding tax rules but may still be treated as a MIT for the purposes of the MIT capital account treatment rules.

5.26 To add further integrity to the MIT withholding tax rules, a trust that breaches the closely held rules (being the small group closely held test and the foreign resident individual closely held test) will not be able to qualify as a MIT.

5.27 The amendments made by this Schedule apply for Subdivision 12-H purposes in relation to fund payments made in relation to the first income year starting on or after the first 1 July after Royal Assent.

5.28 However, in situations where a trustee of the trust made a fund payment before the introduction of this Bill to Parliament, the amended rules do not apply to that trust in relation to the 2010-11 through to 2014-15 income years. This preserves the status of the trust as a MIT if it qualified as a MIT before the amendments made by this Schedule to this Bill. This transitional rule only applies in respect of the MIT withholding tax rules.

5.29 The amended rules apply in relation to Division 275 of the ITAA 1997 (the MIT capital measure) in the same way as the amendments made by Schedule 3 to the Tax Laws Amendment (2010 Measures No. 1) Bill 2010. Generally, this is in relation to certain capital gains tax (CGT) events that happen on or after the start of the 2008-09 income year.

5.30 The amended definition of a MIT also applies to CGT events happening on or after 1 November 2008 for the purposes of Subdivision 126-G of the ITAA 1997.

Comparison of key features of new law and current law

Detailed explanation of new law

Extending the meaning of a MIT

5.31 The current definition of a MIT in item 2 of the table in subsection 12-400(1) requires that a MIS (as defined by section 9 of the Corporations Act 2001) be operated by a financial services licensee (as defined by section 761A of the Corporations Act 2001) whose licence covers operating such a MIS. In this context, the financial services licensee is a person who holds an Australian Financial Services Licence to operate the MIS.

5.32 This requirement in the current law was targeted at MISs that are registered under the Corporations Act 2001, which generally includes 'retail' funds but may also include some 'wholesale' funds - provided the funds are registered.

5.33 The current definition of MIT precludes some unregistered MISs (referred to as unregistered 'wholesale' funds) from qualifying as MITs. This is because an Australian Financial Services Licence to operate a MIS (through a licence to operate a scheme or a class of schemes) only covers what are commonly referred to as registered (retail) MISs.

5.34 While it is possible for the manager of an unregistered MIS to hold an Australian Financial Services Licence, the licence will not necessarily cover the operation of an unregistered scheme - that is, the current legislative requirement that the MIS be operated by a financial services licensee whose licence covers operating such a MIS will not be satisfied.

5.35 When Subdivision 12-H was inserted by the Tax Laws Amendment (Election Commitments No. 1) Act 2008, it was not intended that, as a general rule, MISs operating as 'wholesale' funds were to be excluded from the definition of a MIT.

5.36 Although the Corporations Law did not require unregistered wholesale funds to be operated as registered MISs, previously, subsection 601FC(4) of the Corporations Act 2001 prohibited a registered scheme (for example, a retail fund) from investing in a MIS that was not registered. Therefore, in practice, many wholesale funds did register under the Corporations Act 2001 in order to receive investment funds from the retail funds sector (even though the wholesale fund itself was not required to be registered). With the repeal of subsection 601FC(4) of the Corporations Act 2001, there is a reduced practical need for wholesale funds to be registered MISs.

5.37 Broadly, amendments made by this Schedule ensure that an Australian resident trust that is a MIS that is widely held (and that meets the other requirements to be a MIT) can qualify as a MIT. These are referred to as the general requirements for a trust to be a MIT (and are discussed in paragraphs 5.39 to 5.64) . [Schedule 5, item 4, subsection 12-400(1)]

5.38 Under the new definition of a MIT, the distinction between a registered MIS and an unregistered MIS becomes important in determining whether the trust is widely held, as different rules apply depending on the type of MIS. These are discussed as specific requirements for a registered MIS and for an unregistered MIS in paragraphs 5.65 to 5.74 and 5.75 to 5.98, respectively . [Schedule 5, item 4, paragraphs 12-400(1)(e) and (f)]

What are the general requirements for a trust to be a MIT ?

5.39 For any trust to qualify as a MIT in relation to an income year - whether a registered MIS under section 601EB of the Corporations Act 2001 or not - the following requirements must be satisfied:

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at the time the trustee of the trust makes the first fund payment in relation to the income year, or at an earlier time in the income year the trust has a relevant connection with Australia;

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at the time the payment is made, the trust is a MIS (as defined by section 9 of the Corporations Act 2001);

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the trust is not a trading trust (for a unit trust) or carrying on a trading business (for any other trust) in relation to the income year or controlling the carrying on of such a business; and

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the investment management activities carried out in relation to the trust throughout the income year are carried out in Australia.

[Schedule 5, item 4, paragraphs 12-400(1)(a) to (d)]

5.40 Each of these general requirements is considered in detail in paragraphs 5.42 to 5.64.

5.41 Further to these general requirements, there are specific requirements relevant for a MIS that is registered under the Corporations Act 2001 ( refer to paragraphs 5.65 to 5.74) and for a trust that is not so registered (refer to paragraphs 5.75 to 5.98) . [Schedule 5, item 4, paragraphs 12-400(1)(e) and (f), and sections 12-401 and 12-402]

The trust must have a relevant connection to Australia

5.42 The first requirement to be met is that the trust must have a relevant connection with Australia. At the time the first fund payment is made (or at an earlier time in the income year), the trustee must be an Australian resident or the central management and control of the trust must be in Australia [Schedule 5, item 4, paragraph 12-400(1)(a)]. This requirement currently applies in item 1 in the table in subsection 12-400(1).

5.43 For the purposes of applying the definition of MIT for the capital account election in Division 275 of the ITAA 1997, if no fund payment is made by the trust, section 275-20 will apply to test whether the trust has a relevant connection with Australia on the first and last days of the relevant income year.

The trust must be a MIS

5.44 The second requirement to be met in order to qualify as a MIT is that, at the time the first fund payment is made, the trust is a MIS, as defined in section 9 of the Corporations Act 2001. [Schedule 5, item 4, paragraph 12-400(1)(d)]

5.45 This is the same condition as currently applies in item 2 in the table in subsection 12-400(1) which, when introduced in 2008, was designed to ensure that the MIT withholding tax rules only applied to trusts subject to an appropriate level of regulation within Australia.

5.46 The requirement that the trust be a MIS is an appropriate and reliable measure of the regulation of the trust itself and is designed to:

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ensure only a trust associated with the management of investments as regulated by the Corporations Act 2001 can possibly qualify as a MIT;

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ensure the trust is a genuine collective investment vehicle; and

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limit the ability of foreign residents to establish a trust for the purposes of accessing the MIT withholding tax rate.

5.47 The MIS requirement acts as a safeguard on the types of trusts that can access the MIT withholding tax rates. For example, where interest holders in a trust have day-to-day control over the operation of the trust, it cannot be a MIS and, therefore, cannot qualify as a MIT for withholding tax purposes. This ensures foreign residents cannot simply establish trusts (that are not regulated by the Corporations Act 2001) to qualify as MITs for the purposes of accessing the MIT withholding tax rates on distributions from the trust.

Example 5.1

ABC trust invests in Australian property. The trust is owned by another trust, interests in which are held by more than 50 foreign individual investors. The foreign investors have the day-to-day control of the operation of the trust and the trust does not qualify as a MIS under section 9 of the Corporations Act 2001. ABC trust cannot qualify as a MIT.

The trust must not be a 'trading trust'

5.48 The third general requirement that must be satisfied in determining whether a trust can qualify as a MIT is that the trust must not be:

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in the case of a unit trust, a 'trading trust', as defined under Division 6C of Part III of the ITAA 1936. This exclusion is based on the trading trust definition in Division 6C to ensure consistency with the treatment of unit trusts under that Division [Schedule 5, item 4, paragraph 12-400(2)(a)]; and

•

in the case of any other trust, carrying on a trading business or controlling, or being able to control (directly or indirectly) the affairs or operations of another person in respect of the carrying on by that other person of a trading business (within the meaning of Division 6C in Part III of the ITAA 1936) [Schedule 5, item 4, paragraph 12-400(2)(b)].

5.49 A 'trading business' is a business that does not consist wholly of an eligible investment business. An 'eligible investment business' generally means investing in land for rent, or for the primary purpose of deriving rent, or trading and investing in shares, units and financial instruments.

5.50 For a unit trust, the trading trust test; and for other trusts, the test for what is a trading business - both in Division 6C - are appropriate tests to adopt for the purposes of this measure. This is because the MIT withholding tax rules are targeted at passive investments (as are typically undertaken by genuine collective investment vehicles). This can be contrasted with investments that are more akin to the carrying on of an active business operation. Where a trust carries out an active business operation it is more closely aligned with a commercial business than a collective investment vehicle. Such widely held trusts are generally taxed like companies and are not intended to qualify for MIT concessions.

5.51 A requirement that the trust must not be a trading trust ensures that the definition of a MIT is appropriately targeted to attract and retain foreign investment into trusts that are carrying on an eligible investment business, while ensuring they do not put Australian active businesses at a competitive disadvantage. This ensures a level playing field in terms of tax when active business investments are involved and also reduces the erosion of the corporate tax base.

5.52 While the purpose of the MIT withholding tax rules is to encourage foreign investment, the 'trading trust' test appropriately balances the Government's encouragement of foreign investment into the Australian funds management sector and the protection of the integrity of the tax system.

5.53 The new 'trading trust' tests apply in addition to the current rules that ensure a public trading trust cannot qualify as a MIT (see subsection 102T(16) of the ITAA 1936). Under the new rules, public trading trusts will continue to be denied MIT status. The new rules will also deny MIT status to:

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any unit trust that is a trading trust, including any private trading trust; and

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any other trust that is carrying on (or has control of) a trading business.

5.54 However, a trust that is a MIT under the current law will continue to be eligible to qualify as a MIT for income years up to and including the 2014-15 income year for MIT withholding tax purposes even though it is a trading trust . [Schedule 5, subitem 6(2)]

Example 5.2

PP Trust is an Australian unit trust that is a registered MIS. PP Trust has been operating since 1 July 2008 and had made a fund payment prior to the introduction of this Bill.

PP Trust owns and operates an infrastructure asset in Australia, and derives its income from the operation of that asset. PP Trust is a trading trust (under section 102N of the ITAA 1936), but is not a public trading trust because it is not a public unit trust. One of PP Trust's members is a complying superannuation fund with more than 50 members. Other members of the trust include both resident and foreign resident investors. Based on these facts, PP Trust, having been in operation since 1 July 2009, is a MIT in respect of the 2009-10 income year.

PP Trust will continue to be able to qualify as a MIT for the 2010-11 through to the 2014-15 income years for the purposes of the MIT withholding tax rules.

5.55 The trading trust exclusion for unit trusts is partially ignored for the purposes of Division 275 [Schedule 5, item 1, section 275-5 of the ITAA 1997]. This is to ensure that despite these trusts being excluded from the definition of a MIT for withholding tax purposes, the trust is eligible to make the choice to have capital account treatment apply. However, the trust will not be eligible for deemed capital account treatment while the trust is a trading trust (within the meaning of Division 6C of the ITAA 1936). This is consistent with the policy objective of Division 6C, which is to tax such trusts like companies.

Example 5.3

Assume the same facts as in Example 5.2, except that PP Trust is established on 1 July 2010. PP Trust is a trading trust for the purpose of Division 6C of Part III of the ITAA 1936. It will not qualify as a MIT for withholding tax purposes but will be eligible to make the choice to have capital account treatment apply. However, while it is a trading trust, the trust will not be eligible for deemed capital account treatment.

The investment management activities in relation to the trust must be carried out in Australia

5.56 The fourth general requirement in order for a trust to qualify as a MIT is that the investment management activities in relation to the trust must be carried out in Australia . [Schedule 5, item 4, paragraph 12-400(1)(c)]

5.57 Since the introduction of the MIT withholding tax rules there is evidence that trusts qualifying as MITs are not necessarily managed by the Australian funds management industry. This can occur where the operator (often the trustee) of the trust outsources the investment management control to a fund manager operating outside Australia.

5.58 Permitting such trusts to qualify as MITs would be inconsistent with the objectives of the MIT withholding tax measure, to increase the level of foreign capital managed by Australian fund managers and support the export of Australian funds management services.

5.59 The requirement that the investment management activities be carried out in Australia does not apply for the purposes of the MIT capital account treatment rules in Division 275 of the ITAA 1997 [Schedule 5, item 1, section 275-10 of the ITAA 1997]. The reason for having the investment management activities rule is to ensure the objectives of the MIT withholding tax rules are met. Those objectives are not identical to the objectives of the MIT capital account measure and therefore this requirement is not extended to that measure.

What are investment management activities ?

5.60 At a practical level, the activities involved in operating and managing a fund are quite varied and diverse, and depend on the nature of the underlying investments of the fund. Activities include - but are not limited to - the provision of custodian services, the management and servicing of the underlying assets of the fund (for example, commercial property) and the provision of professional services in relation to various acquisitions, due diligences and disposals of underlying assets.

5.61 These activities can be compared to the investment management activities of a fund - the activities of the fund manager in relation to the investments of the fund. The manager of a MIS is generally appointed to invest and manage the assets of the MIS (the 'portfolio'). The manager must keep the portfolio under review, keep proper books of account in relation to the portfolio and is generally subject to investment instructions (as per the agreement between the manager and operator of the fund) which may set out limitations to the manager's investment discretion.

5.62 Where the manager delegates any of its investment management obligations to another entity, the investment management activities include the activities undertaken in relation to the trust by that other entity. It is these activities that are central to the policy objectives of the MIT withholding tax rules - the policy being that the investment management functions in relation to the fund itself should be carried out in Australia.

5.63 The physical location of investment management activities does not only refer to the place where the final decision to invest (or not) is taken. The fund management activities of the entity must be examined holistically - including market analysis, identification of potential investments and carrying out of due diligence, culminating in the particular investment decision.

5.64 The other activities - such as asset management - that flow from attracting foreign capital to Australia are merely incidental to the fund management activities. It is possible that the asset management activities will occur in Australia in any case regardless of the nature of the investor/purchaser and whether or not such investments are structured through a trust that qualifies as a MIT.

Example 5.4

PT unit trust is an Australian trust that is operated by a trustee (responsible entity) and is a registered MIS. PT unit trust holds commercial property in Australia. It is not a trading trust and has more than 50 members (and so is widely held). Asset management, custodial services, accounting and legal services are provided in Australia, but the fund is managed by SFM Co - a fund manager based in Singapore. SFM Co does preparatory work around market analysis, identifying potential investments and carrying out due diligence on potential investments. This work is undertaken from its office in Singapore.

As SFM Co has no presence in Australia, it is not carrying out the investment management activities in Australia. PT unit trust would not be a MIT (for the withholding tax rules), but would be treated in the same way as a MIT for the purposes of MIT capital account treatment (Division 275 of the ITAA 1997).

Example 5.5

Assume the same facts in Example 5.4, however officers of SFM Co are flown to Australia on two occasions over the course of the income year. While in Australia, these officers make certain investment management decisions as to the purchase of property and carry out final due diligence work associated with that purchase by PT unit trust. SFM Co does not have a physical presence in Australia and has carried out preparatory activities in relation to the investment management in Singapore. Therefore, PT unit trust will not qualify as a MIT for the purposes of the withholding tax rules.

Example 5.6

Assume the same facts in Example 5.4, however, although SFM Co is a fund manager based in Singapore, it has an office through which it operates in Australia. The fund is managed by SFM Co through its office in Australia and all of the investment management activities in relation to PT unit trust are carried out through SFM Co's permanent establishment in Australia. In this case, the requirement that the investment management activities be carried out in Australia is satisfied.

What further specific requirements exist for a trust that is a registered fund ?

5.65 The current law provides that an Australian trust that is a MIS is eligible to qualify as a MIT if, amongst other requirements, it is a MIS operated by a financial services licensee whose licence covers operating such a MIS. The amendments maintain this rule but refer to a trust that is registered under section 601EB of the Corporations Act 2001 [Schedule 5, item 4, paragraph 12-400(1)(e)]. The amendments are intended to have the same effect as the current requirement.

5.66 A trust that is registered will be widely held if it is listed on an approved securities exchange in Australia or has at least 50 members, and is not 'closely held' by a small group (20 or fewer persons) and is not 'closely held' by one foreign resident individual [Schedule 5, item 4, section 12-401]. For the purposes of the small group closely held test, an individual, his or her relatives, and nominees of that individual will be treated as one entity [Schedule 5, item 4, subsection 12-401(2)].

5.67 A trust will be a closely held fund if, at any time in the income year, 20 or fewer persons directly or indirectly:

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hold, or have the right to acquire, interests representing 75 per cent or more of the value of the interests in the trust;

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have the control of, or the ability to control, 75 per cent or more of the rights attaching to membership interests in the trust; or

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have the right to receive 75 per cent or more of any distribution of income that the trust may make.

[Schedule 5, item 4, subparagraph 12-401(1)(b)(i) and section 12-404]

5.68 This percentage in the holding of interest, control of the rights attaching to membership interests, or rights to distribution of income is called the 'MIT participation interest' [Schedule 5, items 3 and 4, subsection 995-1(1) of the ITAA 1997 and section 12-404]. This measurement of interest in the trust is the same as that used in the current law in subsection 12-400(3).

5.69 In addition to the small group closely held test, the trust must also not breach the foreign resident individual closely held test. A trust will breach this test (and, therefore, fail the requirement to be widely held) if, at any time in the income year, one foreign resident individual has a MIT participation interest in the trust of 10 per cent or more . [Schedule 5, item 4, subparagraph 12-401(1)(b)(ii)]

Example 5.7

AF Trust, established in 2008, is a registered MIS with 30 members. One of those members is a foreign limited partnership which has a right to receive 75 per cent of the distribution of income by AF Trust for the 2015-16 income year. As AF Trust is a closely held trust for that income year, AF Trust will not satisfy the widely held requirements and, therefore, will not be a MIT for the 2015-16 income year.

However, if AF Trust made a fund payment in relation to the income year ending 30 June 2009, it would be able to qualify as a MIT (for the purpose of withholding tax) for the income years 2010-11 to 2014-15 (provided in those income years it qualifies as a MIT under the rules prior to the amendments made by this Schedule).

Special rule for start-up and wind-down phases of a trust

5.70 For trusts that are in a start-up phase or a wind-down phase, the widely held requirements will be deemed to be met. However, the wind-down phase rule cannot apply in a year following one in which the start-up phase rule has applied . [Schedule 5, item 4, subsection 12-400(4)]

Includes government-owned MISs

5.71 The amendments allow MISs that are not registered - because they are operated by certain Crown (government-owned) entities and are not required or able to register because of operation of subsection 5A(4) of the Corporations Act 2001 - to be eligible to qualify as a MIT . [Schedule 5, item 4, paragraph 12-400(3)(a)]

5.72 Similar eligibility rules apply to a MIS that is operated by a wholly-owned subsidiary of a Crown entity that would, but for an exemption instrument issued by ASIC under the Corporations Act 2001 that has effect in relation to the entity and operation of the MIS, be required to hold a licence that would cover operating the MIS . [Schedule 5, item 4, paragraph 12-400(3)(b)]

5.73 These rules ensure that government-owned corporations that are bound by all provisions of the Corporations Act 2001 except for Chapters 6A to 6D, 6CA and 7, are treated in the same way as trusts that are operated by a non-government-owned entity.

5.74 Relaxing the Australian Financial Services Licence requirement for state government-owned corporations is consistent with the policy objectives of the MIT withholding tax rules. The amendments ensure that foreign investors in trusts operated by state government-owned corporations can qualify as MITs and be able to access the MIT withholding tax rates. It also ensures a level playing field for trusts operated by state government-owned corporations seeking to attract foreign investment.

What further specific requirements exist for a trust that is an unregistered fund ?

5.75 In addition to satisfying the general requirements to be a MIT (see paragraphs 5.42 to 5.64), a trust that is not registered must also satisfy the following specific requirements:

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the trust must be a genuine wholesale fund;

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the trust must be appropriately regulated; and

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the trust must be widely held.

What funds are genuine wholesale funds ?

5.76 There is no definition of a wholesale fund in the Corporations Act 2001. A trust is determined to be a genuine wholesale fund if, at the time the fund payment is made:

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it is not required to be registered in accordance with section 601ED of the Corporations Act 2001 because of subsection 601ED(2);

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the total number of retail clients that are members of the trust is no more than 20; and

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those retail clients do not have any more than 10 per cent of the interests in, control of, or rights to distribution in, the trust.

[Schedule 5, item 4, subparagraphs 12-400(1)(f)(iii) to (v)]

5.77 Amendments made by this Schedule include a requirement that if the MIS is unregistered, it is because it only provides financial services advice to sophisticated investors (for example, wholesale clients) or only has a small number of retail investors and so is not required to issue a product disclosure statement . [Schedule 5, item 4, subparagraph 12-400(1)(f)(iii)]

5.78 A trust with no more than 20 retail members will be considered a genuine wholesale fund where those retail members hold no more than a 10 per cent interest in the trust [Schedule 5, item 4, subparagraphs 12-400(1)(f)(iv) and (v)]. This de minimis rule ensures the rules defining a MIT are consistent with the Corporate law provisions which allow an unregistered (wholesale) MIS to have up to 20 retail clients.

The trust must be operated or managed by a financial services licensee

5.79 A further requirement that a wholesale fund must meet in order to qualify as a MIT is that it is operated or managed by a financial services licensee, or by an authorised representative of a financial services licensee . [Schedule 5, item 4, paragraph 12-403(1)(a) and subparagraph 12400(1)(f)(ii)]

5.80 Only trusts that are subject to an appropriate level of regulatory oversight should be able to qualify as a MIT. This requirement will be satisfied where an unregistered wholesale trust is either operated or managed by the holder of an Australian Financial Services Licence. The trust may satisfy this requirement in cases where the trustee does not hold an Australian Financial Services Licence but the manager of the fund does - a common scenario in the wholesale fund market. Likewise, a trust may qualify as a MIT where the trustee operator of the fund, but not the manager of the trust, holds an Australian Financial Services Licence . [Schedule 5, item 4, subparagraph 12-403(1)(a)(i)]

5.81 In addition, a trust may qualify as a MIT where the operation or management of the trust is carried out by an authorised representative of the holder of an Australian Financial Services Licence [Schedule 5, item 4, subparagraph 12-403(1)(a)(ii)]. This recognises there may be cases where the operation or management of a trust is delegated by the holder of an Australian Financial Services Licence to another an entity.

Extension to include government-owned MISs

5.82 For similar reasons as provided for registered trusts operated by a government-owned entity, an unregistered government-owned MIS that would otherwise be required to be registered, will be able to qualify as a MIT if the trust is operated or managed by an entity that:

•

would be required under the Corporations Act 2001 to hold a financial services licence but for subsection 5A(4) of that Act (about the Crown not being bound by certain requirements of that Act); or

•

is a wholly-owned subsidiary of such an entity and because of this, the wholly-owned subsidiary is exempt from the requirement to hold a financial services licence because of an instrument issued by ASIC.

[Schedule 5, item 4, paragraphs 12-403(1)(b) and (c) and subsections 12-403(2) and (3)]

5.83 This amendment is targeted at trusts that are operated or managed by government-owned entities and is not intended to cover any broader class of entities for which ASIC may have issued an exemption instrument (which could be for a variety of reasons).

5.84 The reference to subsection 5A(4) of the Corporations Act 2001 is to cover a government-owned corporation. A government-owned corporation is bound by all provisions of the Corporations Act 2001 except for Chapters 6A to 6D, 6CA and 7. Those chapters do not apply to the government-owned corporation under the rules dealing with the application of the Corporations Act 2001 to the Crown in right of the Commonwealth, states and territories etc. Chapter 7 is the chapter dealing with, amongst other things, the requirement to have an Australian Financial Services Licence when operating a financial services business.

When is an unregistered wholesale fund widely held ?

5.85 If a trust is not registered, and it is a genuine wholesale fund (that is, one with predominantly wholesale clients), a different widely held test to the one that applies for retail registered funds must be met.

5.86 A different widely held test is appropriate because, by its nature, a wholesale fund would not be 'widely held'. Therefore, subject to specific closely held tests (see paragraphs 5.96 and 5.97), the widely held test for an unregistered wholesale fund requires the trust have at least 30 wholesale members (which is lower than the 50 member rule that applies for a registered retail fund) . [Schedule 5, item 4, paragraph 12-402(1)(a) and subparagraphs 12-400(1)(f)(i)]

5.87 The 30 member test does not count objects of the trust or individuals (other than individuals that are wholesale clients) as members [Schedule 5, item 4, paragraph 12-402(4)(b)]. It also treats each included individual together with their relatives and nominees as one member [Schedule 5, item 4, paragraph 12-402(6)(a)]. It also treats a member of the trust that is not an individual and nominees of that member as one member [Schedule 5, item 4, paragraph 12-402(6)(b)]. A similar rule also applies for the small group closely held test.

5.88 In determining the number of members of the trust, there is a special rule for counting the members of the trust that are specifically listed widely held entities holding a particular percentage of the value, control of, or rights to, distributions of income from the trust.

5.89 The entities that are covered as specifically listed widely held entities are:

•

a life insurance company;

•

a complying superannuation fund, complying approved deposit fund or foreign superannuation fund, being a fund with at least 50 members;

•

a pooled superannuation trust that has at least one member that is a complying superannuation fund that has at least 50 members;

•

a MIT in relation to the income year; or

•

an entity that is recognised, under foreign law relating to corporate regulation, as an entity with a similar status to a MIS and that has at least 50 members.

[Schedule 5, item 4, subsection 12-402(3)]

5.90 This list is broadly consistent with the list of entities in the current subsection 12-400(2) and is maintained as it represents entities that are, broadly, widely held funds that are collective investment vehicles.

5.91 The list has been extended to include certain pooled superannuation trusts, where at least one member is a complying superannuation fund with at least 50 members. Including these pooled superannuation trusts in the list of specified widely held entities is consistent with the intention of the MIT withholding tax rules and MIT capital account treatment rules when originally introduced.

5.92 The percentage holding by one of these specifically listed entities is multiplied by 50 (generally the minimum number of members that such an entity must have to qualify as a specifically listed widely held entity) to provide a 'notional member' number of members . [Schedule 5, item 4, paragraph 12-402(2)(c)]

5.93 This notional member number is added to the number of any other members (not counted through the notional member count and only including wholesale clients) to determine the total number of members of a wholesale fund [Schedule 5, item 4, paragraph 12-402(2)(d)]. If this number is at least 30 then, subject to not breaching the specific 'closely held' tests (see paragraphs 5.96 and 5.97), the trust would be treated as widely held.

5.94 In identifying the members of the trust that are entities specifically listed in proposed subsection 12-402(3), a specifically listed entity cannot itself be traced-through when applying the interposed trust rule [Schedule 5, item 4, subsection 12-402(5)]. This avoids any double-counting of indirect members through specifically listed entities.

5.95 The effect of this 'notional member' calculation is that an unregistered wholesale trust can qualify as widely held if it has only one member (for tax purposes) and that member is a specifically listed widely held entity [Schedule 5, item 4, paragraph 12-402(2)(c)]. However, the trust would still need to satisfy the remaining requirements to qualify as a MIT, including that the trust is a MIS except where it is wholly owned by certain special entities (see paragraph 5.115) [Schedule 5, item 4, paragraph 12-400(1)(d)].

Example 5.8

The INS Trust is a wholesale trust that is an Australian resident MIS operated by the holder of an Australian Financial Services Licence in Australia. The members of the INS Trust include a life insurance company and a pooled superannuation trust and four other members, two of whom are wholesale clients. The life insurance company has a 40 per cent interest and the pooled superannuation trust has a 30 per cent interest. The members of the pooled superannuation trust include a complying superannuation fund with 50 members.

The INS Trust will be treated as having the equivalent of 20 members from the life insurance company (50 × 40%), 15 members from the pooled superannuation trust (50 × 30%). The total membership of the INS Trust, for the purposes of the minimum (30) membership rule including the other two (2) wholesale members, is 37.

Specific 'closely held' tests for unregistered wholesale MISs

5.96 Even if the unregistered trust has at least 30 wholesale members, it will not qualify as a MIT if it is closely held under either of the following rules:

•

if, at any time in the income year, 12 or fewer persons have a MIT participation interest in the trust of 75 per cent or more (the small group closely held test); or

•

if, at any time in the income year, one foreign resident individual has a MIT participation interest in the trust of 10 per cent or more (the foreign resident closely held test).

[Schedule 5, item 4, paragraph 12-402(1)(b)]

5.97 The number of persons in the small group closely held test, limited to 12 or fewer for unregistered wholesale funds, is lower than that which applies to registered retail funds (20 persons). This is because overall, a registered retail fund must have at least 50 members, while an unregistered wholesale fund must have at least 30 members (40 per cent lower than the level for retail funds). The member number for the small group closely held rule is likewise set at 40 per cent lower than the total member number required for registered retail funds.

Example 5.9

IMF Trust is an Australian trust that is an unregistered MIS. It has three members. One of its members is PS Trust, a pooled superannuation trust. PS Trust itself has five members, one of which is CSF, a complying superannuation fund with 50 members. The second member of IMF Trust is BSF, a complying superannuation fund with 100 members. PS Trust holds a 40 per cent interest in IMF Trust, BSF holds a 45 per cent interest in IMF Trust and Mr Jones (a foreign resident wholesale client) holds a 15 per cent interest in IMF Trust.

For the purposes of the widely held test in proposed subsection 12-402(2), IMF trust has 46 members (20 from the holding by PS trust (50 × 40%) plus 23 from the holding by BSF (50 × 45%) and one from Mr Jones).

However, as Mr Jones, a foreign resident holds an interest in the trust of more than 10 per cent, IMF Trust will not be able to qualify as a MIT.

A special rule for start-up and wind-down phases of a trust

5.98 For trusts that are in a start-up phase or a wind-down phase, the widely held requirements will be deemed to be met. However, the wind-down phase rule cannot apply in a year following one in which the start-up phase rule has applied . [Schedule 5, item 4, subsection 12-400(4)]

Application and transitional provisions

When will these amendments apply from ?

Application of the amendments for MIT withholding tax purposes

5.99 The amendments made by this Schedule apply to fund payments made in relation to the first income year starting on or after the first 1 July after the day on which the amending Act receives Royal Assent and later income years . [Schedule 5, subitem 6(1)]

5.100 However, if before the day of introduction of this Bill to Parliament, the trustee of a trust makes a fund payment in relation to an income year, the amendments made by this Schedule will not apply to that trust for the 2010-11 to 2014-15 income years . [Schedule 5, subitem 6(2)]

5.101 This 'transitional' application rule is to provide time for investors and managed funds to reorder or restructure their arrangements to comply with the new definition of MIT.

5.102 This 'transitional' rule will only apply in relation to the MIT withholding tax rules and will not apply for the capital account treatment rules in Division 275 . [Schedule 5, subitem 6(3)]

Application of the amendments for MIT capital account treatment rules in Division 275 of the ITAA 1997

5.103 The amendments made by this Schedule apply in relation to Division 275 of the ITAA 1997 in the same way as the amendments made by Schedule 3 to the Tax Laws Amendment (2010 Measures No. 1) Bill 2010 apply in relation to that Division.

5.104 Division 275 of the ITAA 1997 allows eligible Australian MITs to make an irrevocable election to apply the CGT provisions as the primary code for the taxation of gains and losses on disposal of certain assets held as passive investments.

5.105 These rules rely on the section 12-400 definition of a MIT and then treat other trusts (that meet conditions set out in the new Division 275) 'in the same way as a MIT'.

Application of the amended definition of a MIT for the purposes of Subdivision 126-G of the ITAA 1997

5.106 These amendments to the definition of a MIT apply for CGT events happening on or after 1 November 2008, consistent with the application date of the limited roll-over in Subdivision 126-G . [Schedule 5, subitem 6(4)]

5.107 This ensures that the extended MIT definition applies to a 'savings clause' that may allow a MIT to access the limited roll-over for fixed trusts even though the trust has material discretionary elements. This ensures that CGT considerations are not an undue impediment to the restructure of affected MITs.

5.108 This savings clause was intended to apply to trusts that would meet the extended definition of a MIT. However, the decision was undertaken to proceed with the rollover without the extended MIT definition as its development was incomplete at that time.

Consequential amendments

5.109 The trading trust exclusion for unit trusts is partially ignored for the purposes of Division 275 [Schedule 5, item 1, section 275-5 of the ITAA 1997]. This is to ensure that despite these trusts being excluded from the definition of a MIT for withholding tax purposes, the trust is eligible to make the choice to have capital account treatment apply.

5.110 The exclusion only applies to the unit trusts that are trading trusts, as other trusts that carry on (or control) a trading business are not covered by Division 275.

5.111 The requirement that the investment management activities be carried out in Australia does not apply for the purposes of the MIT capital account treatment rules in Division 275 of the ITAA 1997 [Schedule 5, item 1, section 275-10 of the ITAA 1997]. The reason for having the investment management activities rule is to ensure the objectives of the MIT withholding tax rules are met. Those objectives are not identical to the objectives of the MIT capital account measure and this requirement is not extended to that measure.

5.112 The amendments made by this Schedule apply for the purposes of Division 275 of the ITAA 1997. Where a fund payment is not made by a trust, the timing rules in section 12-400 that rely on a fund payment being made will be 'deemed' to have been met on the first and last days of the income year under section 275-20 of the ITAA 1997.

5.113 Section 275-15 of the ITAA 1997 is amended to ensure that an Australian trust will not automatically be treated in the same way as a MIT where every member of the trust is a MIT. This situation is now covered by the look-through rule for unregistered wholesale funds where a member is a MIT . [Schedule 5, item 4, paragraph 12-402(3)(d)]

5.114 Trusts that would have been treated in the same way as a MIT under section 275-15 of the ITAA 1997 now must satisfy a further requirement - that the trust is a MIS and is subject to appropriate regulation . [Schedule 5, item 4, paragraph 12-400(1)(d) and subparagraph 12-400(1)(f)(ii)]

5.115 A trust will be treated in the same way as a MIT where the only member of the trust is one of the Australian specified widely held entities (for example, a life insurance company or a widely held complying superannuation fund) or a foreign superannuation fund with more than 50 members, so long as the trust meets the relevant licensing requirements [Schedule 5, item 2, section 275-15 of the ITAA 1997]. This will ensure that these trusts, which are wholly owned by specified widely held entities and, therefore, may not qualify as a MIS under the Corporations Law, are nevertheless able to qualify as a MIT for the purposes of the MIT capital account election rules.

5.116 A consequential amendment is made to paragraph 45-286(b) as a result of the repeal of subsection 12-400(1) . [Schedule 5, item 5, paragraph 45-286(b)]