20% tracing rule in Division 6C
Under the new system for managed investment trusts (MITs), modifications have also been made to the '20% tracing rule' contained in Division 6C of the Income Tax Assessment Act 1936. Division 6C applies to a trust if it is both:
- a trading trust (broadly, a trust that carries on activities other than holding solely passive investments such as shares, property and fixed interest assets)
- a public unit trust.
If Division 6C applies to a trust, the trust will effectively be taxed as a company.
Previously, a trust could be treated as a public unit trust when one or more tax exempt entities or complying superannuation entities owned 20% or more of the beneficial interests in the trust (the 20% tracing rule).
Under the modifications to Division 6C, super funds and exempt entities – that are entitled to a refund of excess imputation credits – will now be exempt from the 20% tracing rule for public trading trusts.
As such, a trust will not be a public trading trust just because certain tax-exempt entities and complying superannuation entities hold more than 20% of interests in the trust.
Consequences for public trading trusts
As a result of the 2016 amendments to modify Division 6C, some trusts cease to be taxed as corporate tax entities for income years starting on or after 1 July 2016.
Trustees of affected trusts will need to consider the impact of these changes on their registration requirements and tax obligations.
If a trust has carried forward tax losses – incurred when it was a public trading trust – then these losses are still deductible by the trust after it ceases to be a public trading trust – provided it satisfies trust loss testing rules in Schedule 2F of the Income Tax Assessment Act 1936.
Some affected trusts will continue to be treated as a corporate tax entity. For example, if the trust is the head company of a consolidated group because it has made a choice under Subdivision 713-C of the Income Tax Assessment Act 1997, the trust will continue to be treated as a company for income years starting on or after 1 July 2016 – despite amendments to Division 6C.
Capital treatment elections
With the sale of eligible assets, the trustee of the MIT can make an irrevocable election to apply only the capital gains tax (CGT) provisions that determine the tax on gains and losses.