House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Taxation relief for Managed Investment Schemes

Overview

A new legal structure for investment funds

2.1 From 1 July 1998, the provisions of the Corporations Law changed significantly for certain investment funds. The most fundamental change was the replacement of a fund's dual structure of trustee and manager with a single responsible entity performing most of the roles previously undertaken by the trustee and manager. Restructuring the investment fund to a single responsible entity structure removes the dual structure's inherent problems of divided powers and responsibilities along with the related legal complexity and uncertainty. Investment funds that adopt a single responsible entity structure under the Corporations Law are described as registered managed investment schemes.

Taxation Relief

2.2 The amendments contained in Schedule 2 to the Bill will amend the Income Tax (Transitional Provisions) Act 1997 to provide relief from unintended tax consequences arising from a managed investment scheme (the scheme) restructuring to become a registered scheme in accordance with the Managed Investments Act 1998 (MIA). These amendments give effect to the Assistant Treasurer's Press Releases No. 37 on 27 July 1998 and No. 10 on 12 March 1999.

2.3 In addition, tax relief will also be available for certain changes to a trust deed not strictly required by the MIA if the changes improve the overall operation of the scheme.

2.4 The amendments will:

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provide schemes with relief from unintended taxation consequences arising from complying with the requirements of the MIA;

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provide schemes with relief from unintended taxation and administrative consequences arising from certain changes that are not strictly required by the MIA; and

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provide members of such schemes with relief from unintended taxation consequences arising from the replacement of their interest in the scheme with an interest in the registered scheme.

2.5 The amendments will achieve the above by:

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treating the creation of a new trust upon the registration of a scheme not to be a creation of a new trust but a continuation of the original trust;

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treating the change in legal entity upon the registration of a scheme not to have occurred and treat the registered scheme as if it were the same legal entity as the scheme immediately before registration;

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treating the change in ownership of the scheme's assets due to the transfer of the assets to the registered scheme not to have occurred;

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treating the change in ownership of a member's interest in a scheme due to the transfer of the interest to the registered scheme not to have occurred; and

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stating a capital gains tax (CGT) event does not happen to either the scheme, or its members, as a result of the scheme becoming a registered scheme.

Relief will also be provided for certain other changes made to the trust deed of the scheme that are not strictly required by the MIA. The other changes are discussed in paragraphs 2.18 and 2.23.

Summary of the amendments

Purpose of the amendments

2.6 The purpose of the amendments is to assist schemes to comply with the MIA by providing relief from any unintended taxation consequences which may arise when schemes become registered schemes. Relief will also extend to the members of such schemes.

Date of effect

2.7 The measure will be effective from 1 July 1998.

Background to the legislation

Purpose of the MIA

2.8 The purpose of the MIA is to overcome possible confusion over the division of responsibility between a scheme's management company and its trustee for the conduct of a scheme's operations. The MIA achieves this by requiring certain schemes to become registered and thereby replace the dual responsibility structure with a single responsible entity. Schemes may also become registered on a voluntary basis.

What is a Managed Investment Scheme?

2.9 The Explanatory Memorandum to the MIA, which amended section 9 of the Corporations Law , explains the essential features of a managed investment scheme in section 9 of that definition. The features are:

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people contribute money in return for a right to benefit from the scheme;

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the contributions are pooled for member's financial benefit; and

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the members do not control the operation of the scheme; or

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the scheme is a time-sharing scheme.

2.10 Generally, such a scheme will be administered as a unit trust.

2.11 For example, a scheme is a type of collective investment such as a public unit trust. In such a trust, a number of investors hand over money or assets to a professional manager who manages the total funds or collection of assets to produce a return that is shared by the investors. Investors, as members of the scheme, hold units in that trust that represent a proportional beneficial entitlement to the trust assets. A unit represents an interest in the scheme.

Who is eligible for relief?

2.12 The relevant entities eligible for taxation relief are schemes which satisfy the definition of a managed investment scheme in section 9 of the Corporations Law and satisfy the requirements described in paragraph 2.17. The members of such schemes are also eligible for relief from any unintended taxation consequences arising because a scheme becomes a registered scheme.

What relief do the proposed amendments provide?

2.13 The restructure of a scheme may result in a new trust being created. The proposed amendments will provide relief from unintended taxation consequences that may arise from the creation of a new trust and the transfer of the original trust's assets to the new trust. Examples of such consequences are:

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assets of the original trust would be disposed of and reacquired (at market value) on transfer. Assets acquired before 20 September 1985 are called pre-CGT assets. A capital gain or capital loss is disregarded in relation to a pre-CGT asset. The asset would lose its pre-CGT status on being transferred to the new trust. If an asset was a post-CGT acquisition (acquired after 19 September 1985), an immediate CGT liability may arise;

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on creating the new trust the original trust ceases to exist, all revenue losses and capital losses belonging to the original trust would not be available to the new trust;

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transfer of traditional securities to the new trust from the original trust would be a disposal or redemption of the traditional securities;

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gains on currency exchange are assessable and losses are deductible to the original trust on the creation of a new trust with capital gains or capital losses being realised on the transfer of the asset to the new trust;

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the transfer of assets to the new trust would give rise to balancing adjustments in respect of some assets subject to the capital allowance rules;

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the benefits of undeducted losses, various categories of unrecouped capital expenditure and uncredited foreign taxes to be carried forward to reduce future tax liability may be lost in the transition to the new trust depending on the circumstances of each particular case;

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foreign tax credits of the original trust are lost as the new trust is not the same entity that generated the credits;

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the transfer of trading stock by the original trust to the new trust would lead to a disposal of the trading stock at market value by the original trust; and

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franking credit trading rules may be triggered in the transfer process from the original trust to the new trust if shares were acquired cum dividend less than 45 days before the creation of the new trust.

Operation of the proposed measures

2.14 To assist schemes which were in existence on 1 July 1998 to restructure under the MIA, the Government proposes to provide relief from any unintended taxation consequences arising from the restructure.

2.15 The restructure will require variation of the trust deed and the removal of the two tier system of manager and trustee. Such changes may create a new entity giving rise to a number of taxation consequences.

2.16 In applying the Income Tax Assessment Act 1936 , Income Tax Assessment Act 1997 (ITAA 1997) and Tax Administration Act 1953 , the proposed amendments treat the creation of a new entity on the restructuring of the scheme to be a continuation of the original entity where the scheme's restructure meets the requirements of these amendments. The amendments will also treat any change in ownership of the scheme's assets or a member's interest in a scheme not to have occurred as a result of the scheme becoming registered. The amendments will provide relief for any unintended taxation consequences affecting both the scheme and its members due to the restructure.

Explanation of the amendments

When schemes qualify for relief?

2.17 Schemes will be eligible for relief if:

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it is a managed investment scheme;

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it makes changes to the scheme to become a registered scheme in accordance with the MIA requirements;

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it existed on 1 July 1998;

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it is administered as the same kind of entity immediately before and immediately after the changes (for example, if the scheme is a unit trust before the changes it must also be a unit trust after the changes to qualify for relief);

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the changes are undertaken during the period 1 July 1998 to 30 June 2000; and

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the membership of the scheme did not alter as a result of the changes.

[New paragraphs 960-105(1)(a) to (f)]

Relief for changes not strictly required by the MIA

2.18 Schemes will also be eligible for relief where changes are made to their trust deed that are not strictly required by the MIA but are done with a view to improving the overall operation of the scheme, if:

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the requirements specified in paragraph 2.17 are satisfied; and

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in comparing the situation immediately before and immediately after the changes:

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the changes made to the scheme did not create shifts in value between members, or classes of members of the scheme; and

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the market value of member's rights was not reduced.

[New paragraph 960-105(1)(g)]

2.19 Example of a typical scheme eligible for relief

2.20 A scheme will also be eligible for relief in the following situation. A listed property trust holds investments in the form of joint ventures, via subsidiary trusts. The MIA requires the listed trust:

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to restructure its trust deed to become a registered scheme; and

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to only invest in other registered schemes.

In order for the listed trust to continue to hold its investments in the subsidiary and partly owned trusts, it is necessary for those trusts to also become registered. Even though the MIA does not specifically require these trusts to restructure, relief is provided to the subsidiary and partly owned trusts if they are schemes that meet the requirements in paragraph 2.17 and become registered schemes. This relief will enable the listed trust to continue to hold investments in those trusts.

2.21 Relief is not provided where a listed property trust holds investments in an entity that is not a managed investment scheme, and that entity restructures in a manner that would bring it within the definition of a managed investment scheme after 1 July 1998 so as to enable that entity to become a registered scheme. This is because the entity was not a managed investment scheme on or before 1 July 1998 as required under the MIA.

When members of a scheme qualify for relief?

2.22 Members of a scheme will be eligible for relief if:

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they are members of a scheme that is eligible for relief;

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they are a member of that scheme both immediately before and immediately after the scheme makes changes to the scheme; and

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where changes are made at different times, they are a member of that scheme both immediately before the first change and immediately after the last change.

[New subsection 960-105(2)]

Examples of changes to a trust deed not strictly required by the MIA

2.23 The following are examples of changes to trust deeds which are not strictly required by the MIA, but meet the above requirements:

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implementing plain English principles, reformatting, re-numbering and removal of typographical errors; and

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areas where deeds are likely to be updated include:

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provisions relating to fees and expense recoveries which include the replacement of the manager and trustee fees with a single responsible entity fee, the replacement of ad valorem fees with a fee basis that remunerates on fund performance basis, allowing for or capping the level of expense reimbursement permitted to be paid to the single responsible entity, imposing a fee for service on individual members in the scheme and changing the calculation basis and the date payable for various classes of fees;

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clarification of the members entitlements;

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the implementation of best practice' scheme pricing in alignment with industry best practice; and

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the updating of the list of investments that the schemes are able to invest in.

Connection with the Income Tax Assessment Act 1997

2.24 The general rule in the ITAA 1997 is that the provisions of that Act apply to assessments for the 1997-98 income year and later income years. Where there are exceptions to this rule a specific transitional provision will be inserted in the Income Tax (Transitional Provisions) Act 1997 . These amendments are examples of such exceptions. The proposed new note in section 4-5 of the ITAA 1997 will provide a signpost to the proposed amendments in the Income Tax (Transitional Provisions) Act 1997 . [Item 2] - REGULATION IMPACT STATEMENT

Policy Objective

2.25 The Government announced in the Assistant Treasurer's Press Release No. 37 of 1998 of its intention to extend tax relief to schemes required to change their two tier manager and trustee structure to a single responsible entity when complying with the MIA

2.26 The measures will extend relief to other changes not strictly required by the MIA but are consistent with the policy behind the MIA. These measures will remove any unintended tax consequences for a scheme that existed on 1 July 1998 and takes action to comply with the MIA within the period beginning 1 July 1998 to 30 June 2000.

Background

2.27 The MIA is the Government's response to recommendations made by the Australian Law Reform Commission and the Company and Securities Advisory Committee in order to promote efficiency and flexibility in schemes and to provide greater investor protection. The proposed tax relief reflects this position.

2.28 The MIA inserted Chapter 5C into the Corporations Law to set out a new regime for the regulation of schemes.

2.29 The MIA allows for a two-year transitional period from 1 July 1998, during which certain schemes in existence on that date must change to the new structure. Schemes, which commence after 1 July 1998, are required to operate under the new rules and are not eligible for relief.

2.30 In addition to the change in a scheme's structure, the MIA requires substantial amendment of a scheme's trust deed.

Identification of implementation options

2.31 There was only one option compatible with the Government's intention to facilitate a smooth, revenue neutral transition for schemes complying with the MIA. That is to amend the taxation laws by providing transitional taxation relief to those schemes.

2.32 The proposed relief will allow schemes to make the necessary structural and operational changes in order to comply with the MIA without unintended taxation consequences arising, provided that:

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the scheme is administered as the same kind of entity immediately before and immediately after making the changes;

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the changes are made during the transitional period between 1 July 1998 and 30 June 2000; and

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the scheme is registered in accordance with the MIA.

2.33 Relief will also be granted in respect of changes to a trust deed not strictly required by the MIA, providing:

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the criteria in paragraph 2.32 are met; and

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in comparing the situation before and immediately after the changes -

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the changes do not create shifts in value between members, or classes of members;

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the market value of members' rights is not reduced; and

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there has been no change in the membership of the scheme.

Assessment of impacts (costs and benefits) of the implementation option

Impact group identification

2.34 The new measures will impact on those schemes that become registered under the MIA and their members. The measures will remove any unintended taxation consequences of the transition to the new regime.

2.35 A scheme's financial and legal advisers will be affected by the measures. One set of obligations - to meet taxation requirements of the creation of a new trust - will be replaced by another - to determine whether the changes made by a scheme are eligible for relief.

2.36 The Australian Taxation Office (ATO) will administer these measures.

Compliance Costs

2.37 The provision of relief upon transition to the MIA may impose some costs on taxpayers and their advisers. These costs would include becoming familiar with the new taxation measures and the maintenance of source documentation.

2.38 However, in the absence of any relief, transition to the MIA would generate extensive compliance costs. The proposed measure will avoid these costs.

2.39 The net impact will be a reduction in compliance costs. However, it is not possible with existing compliance cost data to quantify this reduction.

Administrative Costs

2.40 The ATO does not expect the measures to require further resources beyond those required for the transitional period.

Government Revenue

2.41 As the nature of the relief is to avoid any unintended taxation consequences there will be no impact on Government revenue.

Consultation

2.42 Consultation for the measures was conducted between the ATO, Treasury and the Investment and Financial Services Association (IFSA). No other representative bodies made representations.

2.43 IFSA has expressed broad support for the transitional relief measures being proposed and have requested implementation of these proposals as soon as possible. Treasury strongly supports the measures.

Conclusion

2.44 The measure proposes to allow schemes access relief from any unintended tax consequences and other associated administrative requirements that may result from amending or replacing original trust deeds due to comply with the MIA.

2.45 These changes will facilitate a smooth transition for schemes to the MIA regime.