there should be a separate taxation regime for qualifying MITs, instead of the current trust rules in Div 6, and

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1 10 April 2015 The New Attribution MIT Regime The government has finally released to the public an Exposure Draft (ED) of the regime for taxing income derived through attribution managed investment trusts (AMITs). This will be a critical piece of legislation for the property industry and entities in the funds management sector which operate as trusts or stapled groups. The ED proposes a start date of 1 July This Tax Brief sets out the framework for the new regime and how it is intended to work. Background New rules for taxing income derived through managed investment trusts (MITs) have been under development by Treasury for more than 5 years, since the 2009 report of the Board of Taxation, Review of the Tax Arrangements Applying to Managed Investment Trusts. The then Labor government accepted two key recommendations from that Review there should be a separate taxation regime for qualifying MITs, instead of the current trust rules in Div 6, and unitholders in MITs would be assessable on the amount of taxable income of the trust that the trustee allocates to them (with any unallocated income taxed to the trustee). When the incoming Coalition government decided in late 2013 to jettison a large number of unenacted measures, it announced that it would persevere with this one. A number of the Board s other recommendations were also accepted such as enacting a formal method for dealing with unders and overs, adjustments to the cost base of interests in MITs, deeming MITs to be fixed trusts for various provisions of tax law and repealing Div 6B. One interim recommendation that MITs be permitted to elect for capital gain treatment for gains and losses on certain assets was enacted with effect from But progress on the rest of the project was slow; the start of the regime has been promised for (and then deferred from) 1 July 2011, 2012, 2013 and It is now promised for 1 July A more detailed history of the project is in an earlier Tax Brief. The Exposure Draft (ED) just released by the Government reflects the first public airing (for consultation) of the design features of the new regime. It also reflects some developments in thinking during the 5 years since the Board s report: for example, the ED will allow MITs to issue units that are to be treated as debt for tax purposes (a recommendation originally in the Board s report but which the government was unwilling to accept at the time); there have been some refinements to the definition of MIT; and the unders-and-overs regime has evolved since 2009.

2 Even after 5 years effort, the ED is still a work in progress; we understand that further changes will still be made, including to the start date (refer section 12). Key features of the new AMIT regime Only certain trusts (that are MITs) will qualify as AMITs. Those trusts and MITs that do not qualify will continue to be taxed under the existing trust tax provisions in Division 6. There will be no change to the current MIT withholding tax rate (15% for residents in EOI countries, otherwise 30%). The MIT withholding tax regime will also be available to MITs whether they are AMITs or not. Where a trust meets the AMIT eligibility conditions for the attribution regime, apackage of seven sets of rules are all enlivened: the income attribution mechanism, which includes amounts in the assessable income of unitholders based on their entitlements, a formal system to allow errors in calculating taxable income (referred to as unders and overs ) to be rectified by making adjustments in the year they are discovered, cost base adjustment rules to increase (as well as decrease) the cost base of units for CGT purposes, certain types of units issued by the entity will be treated as debt, both for the trust and the unitholder, the ability to make an irrevocable election to treat income and assets attributable to a class of units as a separate AMIT, a special arm s length rule which can result in a 49% rate of tax payable by the trustee on nonarm s length income earned by a MIT, and the trust is deemed to be a fixed trust, which has important consequences for the trust loss and franking provisions. The two principal eligibility requirements for the new system are the trust is a MIT under the amended definition, and the members of the MIT all have interests that are clearly defined. The relevant eligibility tests must be met for each year and provisions exist to handle trusts which fail to qualify as a AMIT in later years. The requirements to be a MIT, and a AMIT Divs 275-A and 276-A MITs. The ED will move most elements of the definition of MIT from the MIT withholding tax (MITWT) provisions into the main income tax legislation and consolidate those provisions with other aspects of the MIT definition currently found in the deemed CGT treatment provisions. So, the new definition of MIT will be an amalgam of two existing definitions. The ED will make a few changes to the parts of the definition drawn from the MITWT provisions: a trust will be a MIT if it is wholly owned by a MIT (provided it is a resident trust, is non-trading and meets a licensing test), 2 The New Attribution MIT Regime

3 the current definition relaxes the need to meet the widely-held and not closely-held tests for trusts created within the 6 months before the start of an income year. The ED will extend this concession to trusts created within the 12 months before the start of an income year. This extension aligns the treatment on start-up with the treatment on winding up a MIT (ie, it remains a MIT if it is wound up within 12 months after the end of last income year), where interests in a MIT are held by eligible investors, the eligible investor represents multiple members rather than a single member, thus making it easier to satisfy the widely-held test. The ED will add to the list of eligible investors (effective 1 July 2014): a foreign regulated life insurance company, and an entity that is wholly owned by one or more eligible investors. As noted already, the ED blends these updated provisions with other rules currently located only in the deemed CGT treatment rules: a rule which allows a trust to be a MIT even if it makes no fund payments during a year of income a trust will be a MIT if it would have been a MIT if it had made a fund payment on the first and last days of the income year, and a rule which allows a trust to be a MIT where it has not met the requirements due to circumstances that are temporary and outside the control of the trustee (although this concession does not protect against unwittingly engaging in trading activities). AMITs. The ED then builds on that definition to create the new type of entity, the AMIT, which is a subclass of MITs, arising when certain extra tests are met. The trustee and investors in a AMIT are subject to the seven rules noted above: the income attribution mechanism, the under and overs regime, cost base adjustment rules for CGT purposes, units treated as debt, treating classes of units as separate AMITs, the 49% tax on non-arm s length income and being deemed a fixed trust. The principal additional requirement to be a AMIT is that the interests of members in the trust are clearly defined at all times when the trust is in existence in the income year The meaning of the clearly defined interests test is defined in the ED. The basic requirements are that: the amount of taxable income of the trust that is attributed to each member can be worked out on a fair and reasonable basis, the right of each member to income and capital of the trust cannot be materially diminished through exercise of a power or right, and for MITs that are not registered under the Corporations Act, there are two extra requirements which must appear in the constituent documents of the trust: the trustee must be under an obligation to treat all members of the same class equally and members of the different classes fairly, and the constituent documents cannot be modified except in the ways set out in the ED. Importantly, it is not a requirement that interests in a MIT be uniform, nor is it a requirement that they be fixed. Rather, they have to be clear and if variable, the variations can only be made in certain ways. There is also a discretion available for the Commissioner to treat interests in a trust as clearly defined in situations where they might otherwise not be. 3 The New Attribution MIT Regime

4 For reasons which are not obvious, there is a special restriction for trusts that are MITs only because they are wholly-owned by one or more other MITs a sub-trust cannot be an AMIT unless it is whollyowned by a single MIT. Summary Trust is a MIT plus sufficient management eligible for MITWT occurs in Australia Trust is a MIT plus makes election eligible for CGT treatment on certain assets Trust is a MIT plus rights of interests subject to AMIT regime are clearly defined The attribution mechanism and its effects Div 276-C The trust components document As a mechanical matter, the first step in the attribution process is the annual preparation by the trustee of a document which sets out and then characterises the various amounts that the trustee has earned (net of expenses) during the year. Components of assessable income. In the language of the legislation, the trustee must prepare a document which first breaks down the amounts of income earned by the AMIT into various components ( AMIT characters ): types of income (ordinary and statutory income from Australian and foreign sources, capital gains that are discount and non-discount, capital gains from taxable and non-taxable Australian property, dividends, interest, royalties and the gross-up for franking credits), net exempt income and NANE income, and tax offsets (franking credits and foreign income tax offsets). At present there are 15 designated components although the legislation contemplates that more may be created by legislative instrument. The ATO will no doubt use this provision to increase the number of categories so that the reports its receives from trustees, and the information which must be provided to unitholders, are sufficiently nuanced to able to cover all of the permutations which can arise. The sum of the types of AMIT income must total the trust s assessable income computed as if the trust were a resident and a taxpayer. Deductions. Expenses are then deducted from the individual types of AMIT income. The rules about how to allocate expenses are much less prescriptive and require only that deductions which relate directly to an amount of income be deducted against that amount, and all remaining amounts be allocated on a reasonable basis. These rules are unlikely to require significant changes to current practice. Net income / taxable income. These two steps, in effect, produce a calculation of the taxable income of the AMIT for the year (confusingly referred to in current law as the net income of the trust). 4 The New Attribution MIT Regime

5 Ascertaining the taxable member component The second step in the process is to quantify the taxable member component for each unitholder, based on the trustee s determination of the various trust components. The concept of a taxable member component is built up in stages: first, the trustee must determine what portion of each trust component to attribute to each membership interest ( member component ). This is the heart of the attribution system,and substitutes for the current notion of present entitlement. The regime requires that the member component be determined on a fair and reasonable basis in accordance with the constituent documents and without regard to a member s individual tax characteristics; if and when the trustee prepares a document (an AMMA Statement see below) which sets out that amount, it is crystallised into a determined member component. And if the trustee produces several such documents, the determined member component is the amount shown on the last of the documents; the determined member components will comprise amounts that are both taxable and non-taxable (for example, foreign source income which is taxable to a resident unitholder but non-taxable for a non-resident unitholder). Consequently, the last concept is the taxable member component. This is the critical concept which fixes the tax liability of members and trustees. (The terminology is a little confusing as some taxable member components will be taxable, and some will not.) The ED contains a procedure by which a member can challenge the trustee s determination of the taxable member component if the unitholder considers the allocation methodology adopted is unreasonable. The arbiter of this rule is initially the ATO. It is not envisaged that this rule will have any significant impact as it is not a question of which methodology is more reasonable, but rather it can only apply if the trustee s methodology is unreasonable. AMMA statements The last step in the administrative process will be the preparation and distribution of AMIT Member Annual Statements (AMMA statements). This is the document by which the trustee notifies the amount, and the character of amounts, allocated to the member by the trustee, and the amount of any adjustment to the member s cost base in its units. The AMMA statement must be in writing in the approved form and delivered within 3 months of the end of each income year. Tax implications for members So far as unitholders are concerned, the operative provision in the ED revolves around the taxable member component concept. The operative rule provides that taxable member component of each amount has the same effect for the member that it would have if the member had derived the amount in their own right: The taxable member component has an effect for the member in the same way as an amount of that AMIT character would have that effect if the member had derived, received or made the amount reflected in the taxable member component in the member s own right (rather than as a member of a trust) But at the same time, the tax position of the unitholder is to be determined [as] if the member had derived, received or made the amount in the same circumstances as the AMIT derived, received or made the amount that is reflected in that taxable member 5 The New Attribution MIT Regime

6 component, to the extent that those circumstances gave rise to the particular AMIT character of that component. This formulation might look simple and appealing, but it suffers from a fundamental inconsistency. It insists that the tax position of the unitholder is to be determined on one basis: [as] if the member had derived, received or made the amount reflected in the taxable member component in the member s own right and at the same time, the tax position of the unitholder is to be determined on a different basis: in the same circumstances as the AMIT derived, received or made the amount that is reflected in that taxable member component, to the extent that those circumstances gave rise to the particular AMIT character of that component So, in whose shoes does the unitholder stand in its own, or in the shoes of the trustee? For example, what is meant to be the impact on elections eg, can elections made (or not made) by a trustee be un-elected (elected) by a unitholder; what is meant to be the impact where threshholds are relevant eg, can unitholders enjoy benefits conferred on small investors which are not available to large investors (not applying TOFA for example); what is meant to be the impact where the effect is seen in cost base adjustments rather than in amounts being included in income; what is meant to be the impact where the effect is seen in NANE income eg, is a unitholder which is a company to be treated as earning non-portfolio dividends, given that the trustee of the AMIT has to treat such amounts as assessable income; or what is meant to be the impact where the effect is seen in deductions eg, is a unitholder which is a company to be treated as earning non-portfolio dividends so that it can enjoy s ? The ED attempts to resolve this kind of inconsistency in only two cases: it says to ignore the residence of the trustee in deciding how to treat an amount, and ignore whether the trustee does or doesn t satisfy the 45-day rule. Presumably, the verbal formula adopted in the ED is the drafters attempt at capturing the theory that a trust is simply a conduit which does not affect the character of amounts earned through it, and trustees will probably assume that this attempt at capturing the conduit notion in words does not involve any change to law which has adverse impacts on current practice. Relationship to other sections. The ED also contains a provision which attempts to reconcile the rules for AMITs with existing rules which tax unitholders in trusts, Division 6 being the obvious example, and s. 6-5 a less obvious one. The AMIT rules supplant Division 6 entirely but the treatment of s. 6-5 is less obvious. It seems, amounts which will be included in assessable income under s. 6-5 are reduced by the amounts included in assessable income under the AMIT regime. But for some reason, there is an exception for TOFA. If the TOFA provisions would trigger an amount in in the hands of the member, then the TOFA provisions continue to apply, not the AMIT rules. Tax implications for the trustee Div 276-C and 276-J Several provisions in the new regime can impose tax on the trustee. 6 The New Attribution MIT Regime

7 Non-residents. First, where amounts have been properly attributed to non-resident unitholders, provisions in the AMIT regime replicate rules in Div 6 for situations where the trustee is taxed instead of a non-resident who is a unitholder in their own right, or is unitholder as trustee of another trust. The unitholder is then entitled to a credit for the tax paid by the trustee against its own liability. This is the expression of the current ss. 98(3) and 98(4) in the AMIT regime and is needed for an AMIT which does not meet the requirements to invoke MITWT. Non-attribution. Much more difficult are the rules which are directed at breakdowns in the working of the attribution mechanism amounts have not been properly attributed to members. These rules can be thought of as the equivalent of the current s. 99A. An entire sub-division in the legislation is directed to the consequences of shortcomings in the workings of the attribution process. The ED prescribes that the trustee of a AMIT will be liable to pay tax in various situations. They are examples of breakdowns in the attribution process: the trustee will be liable to pay tax if the determined member component is less than the actual member component for that class of income. This unwieldy formulation is simply trying to describe a situation where an income component attributed to a member via their AMMA statement falls short of that member s share of that income component for the year. This could arise for example in a situation where a member successfully contests the amount of a component attributed to them such that the component attributed should have been lower. The trustee will be liable to tax in this instance at the top personal rate; the trustee will have to pay tax if the determined member component is less than the actual member component for exempt or NANE income. The trustee will be liable to tax at the top personal rate; the trustee will have to pay tax if the determined member component is less than the actual member component for tax offsets (other than a franking credit). In this case the rate will be 100% - an amount equal to the tax offset erroneously claimed by the unitholder; the trustee will have to pay tax if the sum of all the determined member components is less than the total trust component for all classes of income. This is trying to describe a situation where the trustee has attributed taxable income of $100 to members but the trust s taxable income is $120. The trustee will be liable to tax at the top personal rate. The first set of rules (directed at shortcomings in allocating individual classes of income) seems to be aimed at situations like those where a member successfully contests the amount of an income component that is attributed to them. The last rule is aimed at situations where not all of the trust s taxable income has been attributed to members. Reconciling the attribution regime with MITWT One very complex piece of the puzzle involves the interaction between the attribution mechanism (which diminishes the significance of cash flows) and the MITWT regime (which depends critically on the fact, size and occasion of cash flows). Resident unitholders will be liable to income tax on the taxable member component (reported on the AMMA statement) regardless of cash flow. In contrast, non-resident unitholders have to be made liable to MITWT and excluded from Australian income tax. The difficulty lies in handling the interaction between collecting tax on cash flows and collecting tax on the amounts reported on the annual AMMA statement: a mechanism has to be retained, which revolves around cash flows, to collect the MITWT from interim payments made during the year, and 7 The New Attribution MIT Regime

8 a new system has to be created, based around AMMA statements, to collect MITWT if insufficient tax payments have been made to the ATO by the stipulated date (which is likely to be 3 months after the end of the income year). The rules work as follows: during the income year, the system will work to collect amounts toward the non-resident s MITWT liability from interim distributions (adjusted to exclude amounts that are interest, dividends, royalties and from foreign sources) as they occur, at the end of the year there will be a reconciliation to the amounts reported on a AMMA statement (adjusted to exclude amounts that are interest, dividends, royalties and from foreign sources and to eliminate any CGT discount), the system would then deem the AMMA statement amount (reduced by any the fund payment component from interim payments; this can be higher than the interim payment) to be paid by the trustee of the AMIT to the non-resident at the time the AMMA statement is issued, deeming this amount to be paid would trigger a liability on the non-resident to pay MITWT on this unpaid amount as well (to the extent MITWT has not already been collected), it would also trigger an obligation on the trustee of the AMIT to send an amount equal to the MITWT on the unpaid amount to the ATO (despite the absence of a cash flow), and the amount remitted by the trustee on the amounts actually paid during the year, and the amount deemed to be paid at the time of issuing the AMMA statement, should extinguish the unitholder s MITWT liability entirely. The exposure draft also includes provisions to deal with other amounts that are subject to withholding tax but are not treated as fund payments (ie interest, dividends and royalties). The treatment of these amounts is slightly different in that the withholding tax is based on the cash distributed with a liability for any shortfall arising on the trustee when the AMMA is issued. The withholding tax rules for AMITs are complicated and reliance will likely be placed on the explanatory memorandum. The system for handling under and overs Div 276-G to 276-H One issue that arose during the consultations with the Board of Taxation, was the difficulty trusts face in dealing with the consequences of modifications to the results of earlier years, such as errors in calculations, information received late, successful resolution of a dispute with the ATO, and so on. In theory at least, if the net income of the earlier year was affected, the trustee should amend the trust s return of the earlier year and notify the unitholders that they need to amend their individual returns. The Board agreed with industry submissions that a simpler solution would be to allow minor adjustments to be incorporated into the tax position of the year of discovery or resolution. For substantial errors, however, the Board offered two options the trustee could elect either to rectify the earlier year s outcomes or else the trustee could pay tax on any shortfall. The design of the unders-and-overs regime has evolved since the 2009 Board of Taxation report. The key features of the regime set out in the ED are: the regime works by adjusting each component of the trust s income for the year in which a discrepancy is discovered, and the adjustment occurs in this year whether or not the discrepancy is substantial, 8 The New Attribution MIT Regime

9 the adjustment is made by comparing the trustee s determination of the amount of each component in an earlier year with the trustee s current knowledge about the actual state of affairs for that year. The comparison is to be made just prior to determining the components for the current year, based on the trustee s knowledge at that time. The comparison is made on a running basis and takes into account any adjustments made in intervening years. The trustee will typically have to keep making these comparisons for 4 years from the date on which the trustee created the trust components document discussed above, where the comparison between the originally determined component and the amount in the year of discovery reveals that the earlier year overstated the component in the earlier year (an over ), the amount is subtracted from the current year component. If the result is negative (the over in the previous for that type of amount is bigger than this year s amount in the same class), the excess is then subtracted from other components. If there is still an excess, it is carried forward to the next year, where the comparison between the originally determined component and the amount in the year of discovery reveals that the earlier year understated the component in the earlier year (an under ), the amount is added to the current year component, there is a special rule where the component in question is a tax offset (either a FITO or a franking credit): an under can be added to the tax offsets in the current year. An over reduces tax offsets in the current year and any excess over will be taxed at 100% (if attributable to a franking credit) or grossed up by the corporate tax rate and added to the foreign income character for the year (if attributable to a FITO), an additional consequence is triggered once the size of the understatements discovered since the initial year exceeds a threshold: the greater of (i) 5% of the sum all of the components (other than franking credits) in the initial year and (ii) 4% of the value of the AMIT s net assets according to the financial statement calculated at the end of the initial year. Where this threshold is exceeded: the amount of a shortfall is increased by an uplift. The uplift factor is calculated using the shortfall interest rate and is applied on a daily compounding basis starting from the 4th month after the end of the initial year until 4 months after the end of the discovery year, and if the under results from intentional or reckless disregard of the law, the trustee will be liable to a further administrative penalty. Note that the unders-and-overs regime is elective trustees can still revise the prior year s results if they wish. Multiple discrepancies. There will obviously be a deal of complexity in handling multiple discrepancies, either within the same base year or arising from several base years. At least three different situations could arise: there can be netting of individual items which are within the same component of trust income. For example, if the trustee discovers in Year 3 that (i) the determination for Year 1 understated one element of the domestic source income component (eg, rental income) by $100 but overstated another element of that component (say, hedging gains) by $100, the net effect on that component in Year 3 will be nil, there can also be netting within the same component of trust income across years. For example, if the trustee discovers in Year 3 that (i) the determination for Year 1 understated domestic source income by $100 but (ii) the determination for Year 2 overstated domestic source income by $100, the net effect on that component in Year 3 will be nil, there is no netting between components in this process. So if the trustee discovers in Year 3 that the determination for Year 1 understated domestic source income by $100 but overstated foreign 9 The New Attribution MIT Regime

10 source by $100, each change is recorded separately because different impacts will be felt in the hands of different unitholders: a resident unitholder will pay tax on nil, a non-resident will be liable to tax on $100. Reconciling unders and overs with trustee assessments. There is obviously a key interaction between these rules and the rules discussed above which tax trustees when insufficient tax has been paid by members reporting their taxable member components under the attribution mechanism. If those rules are invoked, the trustee is taxed on the shortfall in the year of the mistake; if the under-andovers rules are available, the unitholders are taxed on the deficiency in the year of discovery. The intended distinction between these two sets of rules seems to be that the trustee assessment rules are directed at failures in the attribution process while the unders and overs rules are directed at failures in calculating the trust s taxable income. Unders and overs from years prior to the AMIT regime. The ED contains rules about starting the unders and overs element of the AMIT regime. The issue here is how to handle unders-and-overs which arose in years prior to the start of the AMIT regime but are only discovered after the AMIT regime has commenced. The ED proposes, in effect, to back-date the start of the unders and overs regime. It proposes that the under or over be adjusted in the year of discovery (even though the mistake or late development occurred before the trust could have been an AMIT), without any uplift, and that there be no consequences in the earlier year. Ceasing to be a MIT or an AMIT. Under the current MITWT and deemed CGT treatment rules, whether a trust satisfies the definition of a MIT is re-assessed every year and if the trust is a MIT, it is a MIT for all of that year. No adjustment rules exist for trusts that become or cease to be MITs from one year to the next. This system can work for those rules: a trust is or is not a MIT at the time a CGT event occurs; the distribution is liable to MITWT if it relates to income earned in a year when the trust was a MIT. The AMIT regime is more complicated because it needs to retain AMIT status in years whenthe trust is no longer an AMIT. The ED imposes requirements on a trust that was an AMIT in an earlier year: the trust must continue to calculate the various components of its assessable income in subsequent years in order to determine whether subsequent events have revealed a shortfall or excess from a year when it was an AMIT; if there is a discrepancy, that discrepancy is taken into account in the year it is discovered in effect, the under-and-overs regime discussed below continues to apply to the trust after it ceased being a AMIT. CGT cost base adjustment rules Div 104-E Current law includes a complex provision which reduces the cost base of units where a trustee distributes more cash or property to unitholders than the share of net income reported by the unitholder (unless the discrepancy is attributable to amounts which are NANE, assessed to the trustee, personal services income attributed to another entity, income from pooled development funds, infrastructure borrowings, 12-month CGT discount, small business CGT discount, and other reasons). Under the new AMIT regime, the system will made more symmetrical a new provision will increase the cost base of units where a trustee distributes less cash or property to unitholders than the taxable member components reported by the unitholder. The ED takes the opportunity to consolidate the two cost base adjustment rules for AMITs into a single process which is rather different in structure from the current regime in CGT event E4: 10 The New Attribution MIT Regime

11 each year the unit s cost base is reduced by any money or property which the unitholder has received or has a right to receive for that year, plus the amounts of any tax offsets, each year the unit s cost base is increased by the amount included in the unitholder s assessable income under the AMIT attribution regime or another provision, the unit s cost base is also increased by any amounts (such as CGT discount or small business CGT discount) which would not deplete cost base under the current CGT event E4. The net effect of these movements to cost base in any year could be positive or negative. Where the net effect is negative, the cost base of the unit is reduced; where the net effect is positive, the cost base of the unit is increased. Ordinarily these adjustments to the cost base are treated as occurring just before the end of the income year. However, if a CGT event happens to the unit during a year (eg, the unitholder sells the unit), the cost base adjustments have to be made just before the event occurs. The ED also creates a new CGT event E10 which triggers a capital gain if there is a net reduction to the cost base of a unit in a AMIT and the net reduction is greater than the remaining cost base. The event does not happen to units that are pre-cgt. The trustee will be responsible to provide the necessary information so that this regime can work at the unitholder level. It will have to report on the AMMA statement the net impact of these calculations and the adjustment which the unitholder will then have to make to the cost base of units. It is not clear how that can happen when the AMMA Statement is an annual document which reports the net effect for a year calculated at the end of the year. Unitholders who have sold mid-year apparently need this information calculated just prior to the date of sale. Debt-like units Div 276-M Industry submissions made to the Board of Taxation sought the ability for MITs to be able to issue units which would be classified as debt for tax purposes that is, deductible in computing the trust s net income, and assessable as interest (or at interest withholding tax rates) in the hands of unitholders. The Board recommended such a rule. The rule which appears in the ED is very narrow, and it is proposes yet another notion of debt, this time just for AMITs. Rather than using the notion of debt in the debt-equity rules or the notion of a financial arrangement in TOFA, the ED has a third attempt at defining debt. In order to be debt-like the relevant unit must meet 3 tests: distributions on the unit must be calculated by reference to the amount subscribed but payable at the discretion of the trustee, the unit ranks above other units if the AMIT is under administration or wound up, and the constitution insists that the trustee must make a distribution on this unit if it wants to make a distribution on another unit. The operative rules then provide that distributions on such units are an allowable deduction to the AMIT in calculating the trust components. So far as unitholders are concerned, the rules provide that returns on the instrument are assessable to unitholders as if they held a debt interest. It is not obvious that this deeming will actually accomplish what the drafters are intending as the mechanical rules about including amounts in income as interest do not turn on whether the instrument in question is a debt interest. For non-residents, the rule is much cleaner: they are liable to tax on their returns as if the distributions on the unit were interest. 11 The New Attribution MIT Regime

12 The conditions which the relevant unit must meet are somewhat odd and it remains to be seen whether this measure will prove useful to AMITs. It may be that issuing forms of debt that are not based around units will remain the best option for AMITs. Arm s length income rule Div 267-L The sting-in-the-tail in the AMIT regime is the new proposal for a 49% tax, imposed directly on the trustee, on any non-arm s length income earned by a AMIT. The ED provides that the trustee must pay tax on an amount of non-arm s length income derived by a AMIT. Non-arm s length income is any income arising from a scheme where the parties were not dealing with each other at arm s length, and the amount of income is greater than might have been expected if the parties had been dealing at arm s length. (There is no requirement that both parties be related or under common ownership). The gross amount can reduced by any deductions directly attributable to the non-arm s length income. In order to preserve the trustee tax, this amount is excluded from forming part of the trust s taxable income (so that it is excluded from amounts that would be taxed in the hands of unitholders). It is important to note that this rule can only be enlivened where the AMIT is a party to the transaction (as the recipient of an amount of ordinary or statutory income) and the other party is not an AMIT. The rule does not apply to distributions from corporate entities or a trust that is not a party to the relevant scheme. There is also a safe harbour for debt interests where the rate of interest does not exceed the greater of the benchmark rate of return and the SIC rate. Fixed trust treatment Div 276-B One of simpler provisions in the ED says to treat a member of a AMIT has having a vested and indefeasible interest in a share of the income and capital of the AMIT throughout the income year. This formula is used in other parts of the legislation (notably, the trust loss rules and the 45-day rule for accessing franking credits) to define whether a trust is a fixed trust. Deeming interests in a AMIT to be vested and indefeasible is intended to satisfy those definitions, making it easier for AMITs to use trust losses and for their members to enjoy franking credits. Other measures in the ED The ED also includes two other measures which amend the existing law and are not tied to the AMIT regime. Unit trusts with superannuation funds as members. Under the current rules in Div 6C, a trust will be a public unit trust (and therefore potentially exposed to being taxed like a company) if 20% of trust distributions were paid to exempt entities, and the definition of exempt entities extends to superannuation funds. The Board of Taxation recommended that this rule should be narrowed to apply just to entities that are truly exempt. The ED will change the current law to provide that an entity which is eligible for a refund of franking credits (such as a complying superannuation fund) should not be regarded as an exempt entity so that the possibility of a trust being taxed under Div 6C is reduced. This change will apply from 1 July Repeal of Div 6B. The Board of Taxation also recommended that Div 6B should be repealed. This section was enacted in 1980 to apply where a listed or widely-held trust is spun-off from a company. It was largely superseded by the enactment of Div 6C in 1985 which was directed at preventing listed 12 The New Attribution MIT Regime

13 or widely-held trusts (however formed) from conducting active trade or business. The Board regarded Div 6B as redundant and the ED will repeal it. This change will apply from 1 July Start date and transition As currently drafted, the proposed changes in the ED will apply to income years starting on and after 1 July 2015 (except to the two additions to the list of eligible investors, which apply from 1 July 2014). Other potential changes It is anticipated that further changes will be made during the ED consultation period. We understand that treasury is considering the following: changing the start date to 1 July 2016, or 1 July 2015 for those who elect to opt in earlier. Given the timing of the ED, we expect that this change will be made, making the rules elective for MITs that are in existence before the rules are introduced into Parliament, and make consequential amendments to the Tax Law to reflect the repeal of Division 6B (eg section 128FA that provides a withholding tax exemption for certain borrowings by trusts) 13 The New Attribution MIT Regime

14 For further information, please contact Sydney Manuel Makas phone Graeme Cooper graeme.cooper@greenwoods.com.au phone Melbourne Toby Eggleston toby.eggleston@greenwoods.com.au phone Perth Nick Heggart nick.heggart@greenwoods.com.au phone G&HSF document ID The New Attribution MIT Regime dated 14 April 2015.docx These notes are in summary form designed to alert clients to tax developments of general interest. They are not comprehensive, they are not offered as advice and should not be used to formulate business or other fiscal decisions. Liability limited by a scheme approved under Professional Standards Legislation Greenwoods & Herbert Smith Freehills Pty Limited (ABN ) Sydney Melbourne Perth ANZ Tower, 161 Castlereagh Street, Sydney NSW 2000 Australia Ph , Fax Collins Street, Melbourne VIC 3000, Australia Ph Fax QV.1 Building, 250 St Georges Terrace, Perth WA 6000, Australia Ph Fax The New Attribution MIT Regime