House of Representatives

Tax Laws Amendment (2007 Measures No. 3) Bill 2007

Tax Laws Amendment (2007 Measures No. 3) Act 2007

Explanatory Memorandum

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

Chapter 11 New withholding arrangements for managed fund distributions to foreign residents

Outline of chapter

11.1 Schedule 10 to this Bill amends the Taxation Administration Act 1953 (TAA 1953) to implement a new withholding regime for distributions to foreign residents of net income of managed investment trusts attributable to Australian sources (either directly or through certain Australian intermediaries). Income consisting of dividends, interest or royalty income is generally excluded from this measure, as are capital gains on assets other than taxable Australian property.

11.2 Consequential amendments are made to the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997). Legislative references in this chapter are to provisions in the TAA 1953 unless otherwise stated.

Context of amendments

11.3 Under the current law, as proposed to be amended by Schedule 9 to this Bill, a trustee of a managed investment trust would be liable to pay tax on a beneficiary's share of the net income of the trust if the beneficiary is a foreign resident at the end of the income year and is presently entitled to income of the trust. The rate at which tax is payable depends on whether the foreign resident is a company, individual or trustee. This means that trustees of Australian managed investment trusts need to have regard to whether the foreign resident beneficiary is a company, individual or a trustee of a trust to determine the correct amount of tax payable.

11.4 In practice, most distributions made from Australian managed investment trusts to foreign residents are made through one or more Australian intermediaries. There is uncertainty about the nature of the legal relationship between Australian intermediaries, managed investment trusts and foreign resident investors, which could vary depending upon the terms and conditions of the arrangement under which the intermediary provides its services. This creates uncertainty about taxation obligations in terms of both the requirement to pay tax and the rate of tax payable.

11.5 The arrangements in this Schedule will simplify the existing tax collection mechanisms and avoid the complexities and uncertainties that could otherwise occur. They will do this by requiring withholding at a single rate for affected payments by managed investment trusts and intermediaries to foreign resident investors, regardless of the identity of the foreign resident or the relationship between the foreign resident investor and the intermediary.

Summary of new law

11.6 These amendments require trustees of managed investment trusts, that make certain payments directly to foreign residents, to withhold from the payments at the company tax rate. Provided relevant notices are provided by payers, payments made from managed investment trusts indirectly through one or more Australian intermediaries are also subject to the withholding regime. In this situation, the Australian intermediary making the payment to the foreign resident will withhold at the company tax rate.

11.7 Payments covered by this measure are, broadly speaking, payments of income of a managed investment trust to the extent they form part of the net income of the trust, excluding dividends, interest, royalties, foreign source income and capital gains on assets that are not taxable Australian property. Dividends, interest and royalty payments are generally excluded because they are already ordinarily subject to their own withholding tax arrangements in Division 11A of Part III of the ITAA 1936. Foreign source income and capital gains on assets that are not taxable Australian property are excluded because these are generally not taxable in the hands of foreign residents.

11.8 Because, at the time of payment, the trustee of the paying managed investment trust or intermediary is unlikely to know whether the payee is a foreign resident or the actual component of the distribution that will form a part of net income, the arrangements allow for certain estimates and assumptions to be made about these facts.

11.9 The ultimate beneficiary is taxed on the relevant portion of their share of net income which is reasonably attributable to an amount that is subject to withholding. An appropriate portion of the amount withheld is available to the ultimate beneficiary as a credit.

Comparison of key features of new law and current law

New law Current law
The trustee of the managed investment trust is liable to withhold an amount upon certain payments to a foreign resident. The rate of tax is independent of whether the beneficiary is an individual or company, or is acting in the capacity of a trustee. A trustee of a managed investment trust is (like any other trustee) liable to pay tax on a foreign resident company or individual beneficiary's share of the net income of the trust if the company or individual is itself not acting in the capacity of a trustee. The rate of tax depends upon whether the beneficiary is an individual or company.
An Australian intermediary must withhold an amount from certain payments to foreign residents. Payments from which withholding is required are those paid out of certain amounts received from a managed investment trust (either directly or through other intermediaries). The rate of tax is independent of whether the foreign resident is an individual or company, or is acting in the capacity of a trustee.

An Australian intermediary who acts as a trustee is (like any other trustee) liable to pay tax on a foreign resident company or individual beneficiary's share of the net income of the trust if the company or individual is not acting in the capacity of a trustee.

An Australian intermediary that acts as agent for its foreign resident client is not liable to pay tax on the client's share of the net income of a managed investment trust. Instead, the trustee of the managed investment trust is liable to pay tax.

The rate of tax in either case depends upon whether the beneficiary is an individual or company and whether the beneficiary is acting in the capacity of trustee.

An ultimate beneficiary who is taxable on amounts included in its assessable income that are reasonably attributable to an amount that is subject to withholding under the present measure is entitled to a credit for a relevant portion of the amount withheld. A beneficiary of the managed investment trust or trustee intermediary may be entitled to a deduction from their tax if their income includes an amount of net income of the trust in respect of which the trustee has been subject to tax.
If the amount on which a managed investment trust or Australian intermediary pays to a foreign resident includes a discounted capital gain, then the withholding is calculated as if the discount had not applied to the capital gain. If the amount on which a managed investment trust or Australian trustee intermediary is to be assessed in relation to a foreign resident beneficiary includes a discount capital gain, then the capital gains tax (CGT) discount:

·
applies to that gain in determining the amount on which the trustee is assessed (if the beneficiary is an individual not acting in a trustee capacity); and
·
does not apply to that gain in determining the amount on which the trustee is assessed (if the beneficiary is an individual acting in a trustee capacity, or the beneficiary is a company).

Detailed explanation of new law

When is the trustee of a managed investment trust liable to withhold?

11.10 These amendments ensure that certain payments made in relation to an income year - referred to in the amendments as 'fund payments' - by the trustee of a trust that qualifies as a managed investment trust, are subject to withholding if paid to a foreign resident (or someone the trustee believes to be a foreign resident).

Which trusts qualify as 'managed investment trusts'?

11.11 To qualify as a managed investment trust for an income year, three requirements must be satisfied at the time of the making of the first fund payment:

·
the trust has a relevant connection with Australia;
·
the trust satisfies certain Corporations Act 2001 requirements pertaining to the management of investments; and
·
the trust is either listed or is widely held.

Testing at the time of the first fund payment

11.12 These amendments test a trust at the time of the first 'fund payment' in relation to an income year to determine whether it qualifies as a managed investment trust for the whole income year. This is to provide certainty in determining whether payments made by the trust are subject to withholding during the income year.

Connection with Australia

11.13 The first requirement is that the trust must be an 'Australian' trust, in that it has a sufficient connection with Australia. This connection must exist at some time during the income year up to and including the time of making the first fund payment, and can be established in two ways. First, the connection with Australia can be established by the trustee of the trust being an Australian resident at a relevant time. Alternatively, the connection with Australia can be established by the trust's central management and control being in Australia at a relevant time. [Schedule 10, item 1, item 1 in the table in paragraph 12-395(1)(b )]

The Corporations Act 2001 requirements to manage investments

11.14 The second requirement is that the trust must satisfy certain conditions concerning the management of investments. To meet this requirement, the trust must, at the time of making the first fund payment for the income year, be a 'managed investment scheme' and be operated by a 'financial services licensee' whose licence covers operating such a managed investment scheme. The terms 'managed investment scheme' and 'financial services licensee' are defined in the Corporations Act 2001 . [Schedule 10, item 1, item 2 in the table in paragraph 12-395(1)(b )]

Requirement of listing or of being widely held

11.15 The third requirement is that the trust must be listed or widely held in the sense that the trust has at least 50 members (ignoring objects of a trust) at the time it makes the first fund payment for the income year. These amendments allow look-through of some entities, so that the 50 member requirement is met if at least one specified entity (in general, entities that hold investments collectively for their clients and have at least 50 members themselves) is a member of the trust or indirectly holds interests in the trust through one or more trusts that themselves are Australian managed investment schemes. [Schedule 10, item 1, item 3 in the table in paragraph 12-395(1)(b) and subsection 12-395(2 )]

11.16 The requirement that the trust has 50 members (or can establish the relevant connection with an entity that itself has 50 members) aims to reduce the compliance costs associated with an unlisted trust determining whether it holds investments on behalf of a sufficient number of investors. If the trust does not have 50 members, nor can it establish the relevant connection with an entity that itself has 50 members, it cannot satisfy this requirement. This is the case even if, say, the trustee could establish the relevant connection between the trust and two or more entities, which together have more than 49 members.

Concentration test - substantial interests of foreign residents

11.17 To ensure the ownership of units in a managed investment scheme are not concentrated in a few foreign members (or even one foreign member) despite the 50 member test being satisfied, a trust is not considered to be widely held if one or more foreign resident individual members have, directly or indirectly, a 10 per cent or more interest in the trust. [Schedule 10, item 1, subsection 12-395(3 )]

Start-up and wind-up phases of a managed investment trust

11.18 In recognition that the listing and widely held requirements may be difficult to satisfy when the managed investment scheme is starting or winding up, these amendments provide a dispensation in certain circumstances from the requirement to be widely held or listed applicable to the income year in which the trust is created or is wound down.

Start-up phase

11.19 A trust is treated as a managed investment trust for the year in which the trust is created if it has the relevant connection with Australia and fulfils the Corporations Act 2001 requirements identified above at the time of the first 'fund payment' for the income year. The listed or widely held requirement does not have to be satisfied for this income year. [Schedule 10, item 1, subsection 12-395(4 )]

Wind-up phase

11.20 A trust is also treated as a managed investment trust for the year in which the trust ceases to exist if it has the relevant connection with Australia and fulfils the Corporations Act 2001 requirements identified above at the time of the first 'fund payment' for the income year, provided it also qualified as a managed investment trust for the preceding income year. This is so whether or not the trust is widely held or listed at the time it makes the first fund payment for the year in which the trust ceases to exist. [Schedule 10, item 1, subsection 12-395(5 )]

11.21 In determining whether the trust satisfies the requirement to be a managed investment trust for the preceding year, the trust cannot rely on the start-up rule. This means the wind-up phase rule can only apply in the wind-up year if the trust was a managed investment trust in the preceding year because it was actually listed or widely held at the relevant point of time during that year - a trust cannot qualify as a managed investment trust for two successive income years by having the start-up phase and wind-up phase rules applying successively in the respective years. [Schedule 10, item 1, paragraph 12-395(5)(b )]

What payments qualify as 'fund payments'?

11.22 A three-step process needs to be followed to work out how much of a payment made by a trustee of a managed investment trust is a 'fund payment'. The objective of the process is to identify how much of the payment represents, in effect, a distribution of net income (adjusted by ignoring 'excluded amounts' and related deductions) such that the total of fund payments made by the managed investment trust equals, as nearly as practical, the net income of the trust (suitably adjusted) for the income year [Schedule 10, item 1, subsection 12-400(1 )]. This process requires an estimation at the time of payment of what the adjusted net income of the trust for the year will be and what other fund payments will be made by the trust relating to the year.

11.23 The first step is to reduce the payment by that portion of the payment attributable to:

·
interest, dividend or royalty income, subject to (or exempted from) withholding under Division 11A of Part III of the ITAA 1936;
·
any capital gain on a CGT asset that is not taxable Australian property; or
·
amounts that are not from an Australian source.

These exclusions are called 'excluded amounts'. The payment so reduced is the step 1 amount. [Schedule 10, item 1, step 1 in the method statement in subsection 12-400(2)]

11.24 Dividends, interest and royalty payments are generally excluded in calculating the step 1 amount because they are already ordinarily subject to their own withholding tax arrangements in Division 11A of Part III of the ITAA 1936. Foreign source income and capital gains on assets that are not taxable Australian property are excluded because these are generally not taxable in the hands of foreign residents.

11.25 The second step requires the trustee to work out, based on their knowledge at the time of payment, the amount that it is reasonable to expect will be the net income of the trust for the current year, disregarding excluded amounts, expected excluded amounts, and deductions related to either of these amounts. This estimate of adjusted net income is the step 2 amount . This process of determining a reasonable estimate of the net income of the trust is necessary because net income is an amount that can only be ascertained at the end of a trust's income year. [Schedule 10, item 1, step 2 in the method statement in subsection 12-400(1), subsection 12-400(3 )]

11.26 Excluded amounts are disregarded in calculating the step 2 amount for the same reason they are disregarded in calculating the step 1 amount.

11.27 In undertaking this second step, the trustee of a managed investment trust must ignore the CGT discount in estimating the net income of the trust. The trustee does this by doubling any amount that it is reasonable to expect will be included within the net income of the trust as a discount capital gain. [Schedule 10, item 1, paragraph (b) of step 2 in the method statement in subsection 12-400(2 )]

11.28 The amount of any such discount capital gain is required to be doubled because these amendments do not require the trustee, in assessing its own tax obligations, to make a determination of the identity of the foreign resident recipient as an individual or company, or whether the individual or company is acting in the capacity of a trustee. The rule ensures that a company beneficiary cannot access a CGT discount to which it is not entitled. However, this rule does not prevent the foreign resident, if eligible, from claiming the CGT discount in their Australian tax return.

11.29 The third and final step in ascertaining how much of a payment is a fund payment involves a conclusion as to how much of the payment may reasonably be considered a distribution of net income (suitably adjusted) having regard to:

·
the object of the three-step process;
·
the step 1 amount;
·
amounts of earlier fund payments that have been made during the year (disregarding excluded amounts); and
·
expected amounts of any later fund payments to be made during the year (again disregarding excluded amounts).

[Schedule 10, item 1, step 3 in the method statement in subsection 12-400(2 )]

11.30 Whether it is reasonable to conclude a specific portion of the payment is a fund payment is to be determined on an objective basis. That is, the test is whether a reasonable person would consider that that portion could be expected to form a part of the net income (suitably adjusted) of the trust at the end of the income year.

Example 11.1: Calculation of fund payments The Jervis Managed Fund, a managed investment trust, makes three distributions per annum. At the time of its first distribution, a reasonable estimation of its net income (net of excluded amounts and deductions relating to those amounts) based upon the knowledge of the trustee of the Fund at that time is as follows:

Income/Expense July to Oct Nov to Feb March to June Total
Dividends ( A ) $200 $200 $200 $600
Interest income ( B ) $50 $50 $50 $150
Rental income ( C ) $250 $250 $285 $785
Rental expenses ( D ) ($0) ($300) ($135) ($435)
Other assessable income ( E ) $500 $0 $0 $500
Other deductions ( F ) ($350) ($0) ($200) ($550)
Capital gains from taxable Australian property (gross) ( G ) $0 $850 $0 $850
Other distributable amounts (eg, tax preferred amounts) ( H ) $100 $150 $100 $350
Total (I = A + B + C - D + E - F + G + H) $750 $1,200 $300 $2,250
Total (net of excluded amounts) ( J = I - A - B ) $500 $950 $50 $1,500
Net income (net of excluded amounts) ( K = J - H ) $400 $800 ($50) $1,150
The Fund decides to pay an amount of $750 as its first distribution, $250 of which is attributable to interest and dividend income received by the Fund.The Jervis Managed Fund would calculate how much of the $750 payment is a fund payment as follows:Step 1: The amount of the payment net of 'excluded amounts' (being the $250 of interest and dividend income to which the payment is attributable) is $500.Step 2: Based on the trustee's knowledge at the time of the payment, it is reasonable to expect that the net income of the trust for the year, net of excluded amounts and deductions relating to those amounts (assuming none of the deductions relate to excluded amounts), will be $1,150.Step 3: The Fund expects, as at the time of making its first distribution, that the two other distributions it will make for the income year will total $1,500 ($1,000 when excluded amounts are disregarded). As such, the amount of the first payment that is a fund payment is that portion of $1,150 (the adjusted net income) as is reasonable having regard to the present (adjusted) payment of $500 and the expected (adjusted) future payments of $1,000.As the Fund expects to pay $1,500 in (adjusted) distributions over the year and as the expected (adjusted) net income of the trust for the year is expected to be $1,150, it is reasonable to conclude that the portion of the present payment that is a fund payment is the result of multiplying the fraction (1,150/1,500) x $500, that is $383.33. If the $750 payment is made to a foreign resident, the trustee should withhold 30% x $383.33, equalling $115.00.If, however, there was significant uncertainty at the time of payment about the future, it may be reasonable to conclude that the portion of the payment that is a fund payment is different to $383.33.For example, if there is sufficient uncertainty about amounts that could be paid in future as fund payments as well as net income, it may be reasonable to treat $400 as the fund payment. If there were sufficient uncertainty about amounts that could be paid in future as fund payments but it was expected that the net income of the year may approach total (adjusted) payments for the year, it may be appropriate to treat a greater amount than $400 as a fund payment. However, the maximum portion of the payment that can be recognised as a fund payment is $500 (ie, the step 1 amount for the payment). Example 11.2: Calculation of fund payments Assume, in contrast to Example 11.1, that at the time of the first distribution, Jervis Managed Fund instead estimates its net income for the year to be as follows:
Income/ Expense July to Oct Nov to Feb March to June Total
Dividends ( A ) $200 $200 $200 $600
Interest income ( B ) $50 $50 $50 $150
Rental income ( C ) $250 $250 $200 $700
Rental expenses ( D ) ($0) ($400) ($150) ($550)
Other assessable income ( E ) $500 $0 $0 $500
Other deductions ( F ) ($350) ($0) ($300) ($650)
Capital gains from taxable Australian property (gross) ( G ) $0 $400 $0 $400
Other distributable amounts (eg, tax deferred amounts) ( H ) $100 $100 $100 $300
Total (I = A + B + C - D + E - F + G + H ) $750 $600 $100 $1,450
Total (net of excluded amounts) ( J = I - A - B ) $500 $350 ($150) $700
Net income (net of excluded amounts) ( K = J - H ) $400 $250 ($250) $400
The first payment The Jervis Managed Fund decides to distribute $500 as its first distribution, $250 of which is attributable to interest and dividend income received by the Fund.The Jervis Managed Fund would calculate how much of the $500 payment is a fund payment as follows:Step 1: The amount of the payment net of 'excluded amounts' (being the $250 of interest and dividend income to which the payment is attributable) is $250.Step 2: Based on the trustee's knowledge at the time of the payment, it is reasonable to expect that the net income of the trust for the year, net of excluded amounts and deductions relating to those amounts (assuming none of the deductions relate to excluded amounts), will be $400.Step 3: The Fund expects, as at the time of making its first distribution, that the two other distributions it will make for the income year will total $950 ($450 when excluded amounts are disregarded). As such, the amount of the first payment that is a fund payment is that portion of $400 (the adjusted net income) as is reasonable having regard to the present (adjusted) payment and expected (adjusted) future payments of $700.As the Fund expects to pay $700 in (adjusted) distributions over the year and as the expected (adjusted) net income of the trust for the year is expected to be $400, it is reasonable to conclude that the portion of the present payment that is a fund payment is the result of multiplying the fraction (400/700) x $250, that is $142.86. If the $500 payment is made to a foreign resident, the trustee should withhold 30% x $142.86, equalling $42.00.On this basis, the possible break-down of the distribution of $500 could be as follows:
Interest and dividends $250.00
Fund payment $142.86
Tax deferred amount $107.14
Total distribution $500.00
As discussed earlier, depending upon expectations about the future, it may be reasonable to treat a greater portion than $142.86 of the payment as a fund payment. However, the maximum portion of the payment that can be recognised as a fund payment is $250 (the step 1 amount). The second payment At the time of making its second distribution, the Jervis Managed Fund makes a larger distribution than it originally planned to make. It now makes a second distribution of $900, $350 of which is attributable to interest and dividend income received by the Fund. At the time of making its second distribution, the fund estimates its net income for the year to be as follows:
Income/ Expense July to Oct Nov to Feb March to June Total
Dividends (A) $200 $300 $300 $800
Interest income (B) $50 $50 $50 $150
Rental income (C) $250 $450 $600 $1,300
Rental expenses (D) ($0) ($400) ($150) ($550)
Other assessable income (E) $500 $0 $0 $500
Other deductions (F) ($350) ($0) ($100) ($450)
Capital gains from taxable Australian property (gross) (G) $0 $400 $1,000 $1,400
Other distributable amounts (eg, tax deferred amounts) (H) $100 $100 $100 $300
Total (I = A + B + C - D + E - F + G + H ) $750 $900 $1,800 $3,450
Net income (net of excluded amounts) ( K =- J - H ) $500 $550 $1,450 $2,500
Total (net of excluded amounts) ( J = I - A - B ) $400 $450 $1,350 $2,200
The Jervis Managed Fund would calculate how much of the $900 payment is a fund payment as follows:Step 1: Amount of payment net of 'excluded amounts' (being the $350 of interest and dividend income to which the payment is attributable) is $550.Step 2: Based on the trustee's knowledge at the time of the payment, it is reasonable to expect that the net income of the trust for the year, net of excluded amounts and deductions relating to those amounts (assuming none of the deductions relate to excluded amounts), will be $2,200.Step 3: The Fund expects, as at the time of making its second distribution, that the final distribution it will make for the year will be $1,800 ($1,350 when excluded amounts are disregarded). The Fund has already made a distribution of $500 ($250 when excluded amounts are disregarded). As such, the amount of the second payment that is a fund payment is that portion of $2,500 (the adjusted net income) as is reasonable having regard to the present payment, the prior and (expected) future fund payments.As the Fund calculated $142.86 of the first payment as representing a payment of net income, and as the Fund expects to pay $1,450 in (adjusted) distributions for the remainder of the year, it is reasonable to conclude that the portion of the present payment, that is a fund payment, is the result of multiplying the fraction(($2,500 - $142.86) / ($1,450 + $550)) by $550, that is $648.21. However, as this is greater than $550 (the step 1 amount), it is reasonable to conclude that the whole payment of $550 is a fund payment.Indeed, if the possibility or likelihood of a revision upwards in expected net income was known at the time of the first payment, it may have been reasonable to treat a larger amount of the first payment as a fund payment.If it was reasonable to treat the entire amount of $550 as a fund payment, the break-down of the distribution of $900 would be as follows:
Interest and dividends $350
Fund payment $550
Total distribution $900
It should be noted that the Fund is unable to over-withhold, that is, it is unable to withhold more than $165 (30% of $550) from a fund payment of $550. The Fund is, however, when making a determination as to what portion of the distribution it is paying constitutes a fund payment, able to take into account expected future income in the year so long as it would be reasonable to do so.

Timing of payments

11.31 In addition, for an amount to qualify as a 'fund payment', it must be paid during the income year to which the payment relates or three months after the end of the income year [Schedule 10, item 1, subsection 12-400(4 )]. This includes payments made constructively (under section 11-5).

11.32 However, this base period of time in which a fund payment is to be made if it is to qualify as a fund payment may be extended by the Commissioner of Taxation (Commissioner) by an additional period of up to three months (starting immediately after the end of the base period), if the Commissioner is of the opinion the trustee was unable to make a payment within the base period because of circumstances beyond the influence or control of the managed investment trust [Schedule 10, item 1, subsection 12-400(5 )]. An example of this would be where a non-associated trust, in which the trustee of the managed investment trust has made an investment, has not provided sufficient information about the constituent parts of a distribution made to the managed investment trust, despite all reasonable efforts by the trustee of the managed investment trust to gain that information.

The obligation on managed investment trusts to withhold

11.33 Where the trustee of a managed investment trust has made a fund payment to a foreign resident (or a recipient the trustee believes or has reasonable grounds to believe to be a foreign resident), the trustee must withhold an amount equal to:

The amount of the fund payment x the company tax rate.
[Schedule 10, item 1, subsection 12-385(2 )]

Often, the trustee of the managed investment trust will not have sufficient information to determine whether a recipient is a foreign resident for Australian tax purposes. Accordingly, the amendments allow the trustee of the managed investment trust to make the assumption that the recipient is a foreign resident in certain cases. This outcome is identical to that provided in other withholding arrangements contained in the TAA 1953. [Schedule 10, item 1, section 12-410]

When is an intermediary liable to withhold?

11.34 These amendments also ensure that fund payments made by trustees of managed investment trusts to certain intermediaries, who then pay amounts to foreign residents (or someone believed to be a foreign resident), are subject to withholding. In these circumstances, however, it is the intermediary that is obliged to make the withholding.

Which entities qualify as an 'intermediary'?

11.35 To qualify as an intermediary in respect of a payment, three requirements must be satisfied at the time of receipt of that payment:

·
the entity has a relevant connection with Australia;
·
the entity satisfies certain Corporations Act 2001 requirements pertaining to the conduct of an intermediary business; and
·
the entity must have received a notice relating to the payment.

Connection with Australia

11.36 The first requirement is that the entity must be an 'Australian' entity, in that the entity must have a sufficient connection with Australia. This connection can be established in two ways. First, the connection can be established by the entity being a resident. Where the recipient is a trustee of a trust, either the trustee of the trust must be a resident, or the trust's central management and control must be in Australia, at the time of receipt of the payment. Second, and alternatively, the connection can be established if the business that satisfies the Corporations Act 2001 requirements (see below) is carried on through a permanent establishment in Australia at the time of receipt of the payment. [Schedule 10, item 1, paragraph 12-405(1)(d) and subsection 12-405(2 )]

Corporations Act 2001 requirements to provide intermediary services

11.37 The second requirement is that the entity is, at the time of receipt of the payment, carrying on a business consisting predominantly of providing 'custodial or depository services' pursuant to an 'Australian financial services licence'. The terms 'custodial or depository services' and 'Australian financial services licence' are both defined in the Corporations Act 2001 [Schedule 10, item 1, paragraph 12-405(1)(a )]. Further, the receipt of the payment must be in the course of this business [Schedule 10, item 1, paragraph 12-405(1)(b )].

11.38 A 'business' can mean something that is a part of a larger business, provided the putative business can itself be meaningfully considered a business when viewed as a stand alone venture.

11.39 In addition, the business need only predominantly consist of providing 'custodial or depository services'. Where the business consists of other activities, provided their extent is not such that the provision of custodial or depository services could not be considered to be the dominant activity of the business, the business conducted by the entity may still be considered to be predominantly consisting of providing custodial or depository services.

The entity has received a notice

11.40 An entity can only qualify as an intermediary in respect of a payment it receives if it has received a notice in respect of that payment on or before the time of receipt of the payment. [Schedule 10, item 1, paragraph 12-405(1)(c )]

11.41 The notice will set out information about the payment that will enable the intermediary to calculate the amount the intermediary will need to withhold if it on-pays the amount received to a foreign resident, such as how much of the payment would have been required to be withheld if the payer had made the payment directly to a foreign resident rather than the intermediary. It will also set out the income year of the paying managed investment trust to which the relevant fund payment relates, which is relevant to determining the income year in which the beneficiary should return assessable income. [Schedule 10, item 1, subsection 12-415(2 )]

11.42 It is not mandatory for a payer to give a notice, and the failure to provide a notice to an entity will simply mean the withholding arrangements in this Schedule will not apply to the entity when it on-pays the payment in respect of which a notice has not been provided. A consequence of this is that the withholding obligation may rest with another entity or, in certain situations, other taxing regimes may operate instead.

11.43 Importantly, a notice can only be provided by a trustee of a managed investment trust or an intermediary. [Schedule 10, item 1, subsection 12-415(1 )]

11.44 This is because a notice may only be given by an entity making a payment from which an amount would have been required to be withheld had the payment been made by the entity to a foreign resident. However, the withholding arrangements in this Schedule only impose withholding obligations on managed investment trusts and intermediaries.

11.45 No notice can be provided by an intermediary in respect of a constructive payment (ie, a payment is deemed to have been made). This is to prevent multiple withholding in the rare case that a fund payment is made through two or more entities that would, but for the notice requirement, satisfy the definition of 'intermediary'. Without this prohibition on the provision of notices, an intermediary could make a constructive payment by dealing with a fund payment it receives (eg, by placing the fund payment on deposit on the instruction of another party). At a later time, if the fund payment were on-paid to the other party and the other party were able to satisfy the definition of intermediary (as it could do if it could be provided with a notice in respect of the payment), then a second withholding obligation may be raised if the other party itself made an on-payment to a foreign resident. [Schedule 10, item 1, subsection 12-415(3 )]

Intermediaries acting as agents for their clients

11.46 Entities that act as agents for their clients (as principals) are treated as a separate entity for the purposes of the new withholding arrangements if they meet the definition of 'intermediary'. [Schedule 10, item 1, paragraph 12-420(2)(a )]

11.47 In addition, the mere act of receipt of a payment by an intermediary acting in the capacity of an agent is not a constructive payment [Schedule 10, item 1, paragraph 12-420(2)(b )]. Rather, any subsequent dealing in the fund payment on behalf of the principal will be taken to be a constructive payment. Examples include depositing the fund payment into an interest-bearing account (whereby the principal becomes entitled to interest) or discharging an obligation of the principal by making payment to another party.

Which payments by intermediaries are subject to withholding?

11.48 An intermediary is obliged to withhold from a payment it makes under the amendments if the payment is made to a foreign resident (or a recipient the intermediary believes or has reasonable grounds to believe to be a foreign resident), and the payment is attributable to an earlier payment that would have been subject to withholding had it been made to a foreign resident instead of the intermediary. [Schedule 10, item 1, subsection 12-390(1 )]

The obligation on intermediaries to withhold

11.49 Where an intermediary has received a payment attributable to a fund payment and in turn makes a payment to a foreign resident (or person the intermediary has a reasonable belief is a foreign resident), the intermediary must withhold an amount equal to:

The amount of the payment made to the foreign resident attributable to that part of the payment received that is covered by the notice provided in relation to the payment x the corporate tax rate. [Schedule 10, item 1, subsection 12-390(2 )]

Similarly to trustees of managed investment trusts, intermediaries are entitled to determine whether a recipient is a foreign resident based upon an application of the same tests as apply to managed investment trusts discussed in paragraph 11.33.

Example 11.3: Fund payment made through an intermediary The Pyke Managed Fund is a trust that satisfies the requirements for being a 'managed investment trust'. The trustee of the Fund gives a notice that satisfies the relevant requirements to Cassandra Custodian Services, an Australian resident company. The trustee of the Fund then makes a payment, a part of which is a 'fund payment' and which is specified by the notice as an amount which, if paid to a foreign resident, would have been subject to withholding. The receipt by Cassandra Custodian Services is in the course of a business that predominantly consists of providing custodial or depository services pursuant to a financial services licence.Cassandra Custodian Services then on-pays the full amount to Tony, a foreign resident individual.As Cassandra Custodian Services satisfies all the necessary requirements, it is an intermediary. As a result, the trustee of Pyke Managed Fund is not required to withhold from the payment to Cassandra Custodian Services.As Cassandra Custodian Services is an intermediary in relation to the fund payment, it will be required to withhold an amount from the payment to Tony to the extent that the payment is attributable to the earlier payment received from, and covered by the notice provided by, Pyke Managed Fund.

Remittance of amounts withheld

11.50 Remittance obligations for amounts withheld will be similar to remittance obligations for other withholdings based on the withholder status of the payer as a small, medium or large withholder.

Credits for amounts withheld

11.51 The pay as you go (PAYG) withholding provisions provide rules to allow for credits for amounts withheld. These rules are in Division 18 of Schedule 1 to the TAA 1953. A new crediting rule, pertaining to managed investment trust withholding, has been inserted into Division 18. The rule specifies the circumstances in which a credit entitlement arises.

11.52 The credit arises if the entity is the beneficiary of a trust and the assessable income of the entity includes an amount that is reasonably attributable to a payment from which an amount was withheld. As is the case for the other withholding rules, it is necessary for an assessment to have been made before the credit entitlement arises. This ensures that a specific time can be established for when the credit arises. [Schedule 10, item 2, section 18-50]

11.53 Credits are also available if the entity is a trustee of a trust, an amount is included in the entity's assessable income under section 99 or 99A of the ITAA 1936, and the amount is reasonably attributable to a 'fund payment' from which an amount was withheld under these amendments. [Schedule 10, item 2, section 18-50]

11.54 However, credits are not available if the entity is a trustee and the assessable income of the trust includes an amount under section 97, except where the trustee is a trustee of either a complying superannuation trust, corporate unit trust or public trading trust. [Schedule 10, item 2, subsections 18-50(5) and (6 )]

11.55 The amount of the credit is so much of the amount withheld multiplied by the 'attributable part of the payment' divided by the amount of the withholding payment. The attributable part of the payment is so much of the 'assessable amount' (which, for this purpose, includes capital gains included in the assessable income of the beneficiary because of subsection 115-215(3) of the ITAA 1997) as is represented by or reasonably attributable to the withholding payment. [Schedule 10, item 2, subsection 18-50(4 )]

11.56 The crediting rule discussed above will not apply in addition to existing crediting rules in section 18-15 or 18-25. This will prevent multiple credit entitlements arising from amounts withheld under the new managed investment trust provisions. [Schedule 10, items 27 and 28, subsections 18-15(3) and 18-25(9 )]

11.57 The PAYG withholding system provides for refunds of amounts to taxpayers where withholding has occurred in error. These rules are in sections 18-65 and 18-70 of Schedule 1 to the TAA 1953. Under the managed fund withholding arrangements, there may be circumstances where the amount withheld by a managed investment trust is subsequently determined to have been different to the amount that would have been withheld if the payer was in possession of information about the net income of the trust or subsequent distributions that was not available to it at the time of payment. An amount will not have been withheld in error in these circumstances simply because the withholding amount would have been different. It is intended that, in working out how much to withhold from a payment, a trustee of a managed investment trust is to work out the expected net income of the trust and expected amounts of future payments on the basis of the trustee's knowledge at the time of the payment. To be an error of a kind engaging the operation of section 18-65 or 18-70, the error must be one that was made at the date of payment having regard to the information that was known to the payer at that time.

Example 11.4: Calculation of credit The Vo Managed Fund is a trust that satisfies the requirements to be a managed investment trust. The trustee of the Fund makes a fund payment of $3,000 to Hunter Custodian Services, an intermediary, representing the entire share of the net income of the Vo Managed Fund that relate to the interests held by Hunter Custodian Services. Hunter Custodian Services on-pays the entire amount to Nguyen Trust, a non-resident trust estate. Withholding tax of $900 (30% x $3,000) arises in respect of this payment. Nguyen Trust has no other income.Nguyen Trust has two beneficiaries: Sheela and Nameeta. Sheela is an Australian resident beneficiary, while Nameeta is a foreign resident beneficiary. Sheela and Nameeta are presently entitled to the trust income of Nguyen Trust.Nguyen Trust's net income of the year of income is $3,000, being the trust's individual interest in the share of the net income of the Vo Managed Fund. The Trust makes payments of $1,800 and $900 to Sheela and Nameeta, respectively. The trustee of the Nguyen Trust is not subject to any tax in respect of these payments as the payments represent income to which the beneficiaries are presently entitled and are reasonably attributable to an amount from which withholding was required by Hunter Custodian Services.Sheela is a beneficiary that is presently entitled to a share of the trust income of Nguyen Trust and is not a beneficiary in the capacity of a trustee of another trust estate. She is therefore assessed on her interest in the net income of the Trust, which is $2,000. On a similar basis, Nameeta is assessed on an amount of $1,000.Both Sheela and Nameeta are entitled to credits for an appropriate proportion of the $900 withheld attributable to the fund payment of $3,000.Sheela's credit is calculated as follows:

(Attributable part of payment ($2,000) / Amount of withholding payment ($3,000)) x Amount withhelf ($900) = $600

Nameeta's credit is calculated as follows:

(Attributable part of payment ($1,000) / Amount of withholding payment ($3,000)) x Amount withheld ($900) = $300

Application and transitional provisions

11.58 The new arrangements will apply to income years beginning on or after 1 July following Royal Assent. [Schedule 10, item 32]

Consequential amendments

Consequential changes to the ITAA 1936

Liability of the ultimate beneficiary

11.59 These amendments ensure that a foreign resident beneficiary that is not a trustee beneficiary is assessed on their share of the net income of the trust where that share is represented by or reasonably attributable to an amount subject to withholding under this measure. [Schedule 10, item 6, section 99F of the ITAA 1936]

Exclusion of Division 6 assessment of trustees where withholding has been made

11.60 The amendments made by this Schedule exclude assessment of the net income of a trust under sections 98, 99 or 99A of the ITAA 1936 in the hands of the trustee to the extent that net income represents income to which a beneficiary is presently entitled and is represented by or reasonably attributable to an amount subject to withholding. The purpose of this is to ensure the operation of Division 6 of Part III of the ITAA 1936 to tax the trustee of a managed investment trust is excluded insofar as withholding by the trustee under these rules is required. [Schedule 10, item 6, section 99G of the ITAA 1936]

11.61 Similarly, in the case of an intermediary that is a trustee, sections 98, 99 and 99A of the ITAA 1936 will not apply to assess the trustee on a share of the net income of the trust to the extent that net income represents income to which a beneficiary is presently entitled and is represented by or reasonably attributable to an amount where withholding was required. As with managed investment trusts, the purpose of this amendment is to ensure the operation of Division 6 of Part III of the ITAA 1936 to tax a trustee intermediary is excluded insofar as withholding by the trustee under these rules is required. [Schedule 10, item 6, section 99G of the ITAA 1936]

11.62 Also, where an amount that is subject to withholding flows through other trust estates, sections 98, 99 and 99A of the ITAA 1936 will not apply to effectively tax the amount again in the hands of a subsequent trustee. Thus, sections 98, 99 and 99A will also not apply to assess the trustee of a share of the net income of the trust to the extent that net income represents income to which a beneficiary is presently entitled and is represented by or reasonably attributable to an amount where withholding was required. [Schedule 10, item 6, section 99G of the ITAA 1936]

Payments made too late to be 'fund payments'

11.63 As discussed in paragraphs 11.31 and 11.32, in order to qualify as a fund payment and, therefore, be eligible for withholding, it is necessary the payment be made (including constructively made) within three months of the end of the income year or within such later period as allowed by the Commissioner. If a foreign resident beneficiary is presently entitled to a share of the income of the trust and that share of the net income is not paid within this period, the trustee will be assessed as if no-one was presently entitled to the share of income. The trustee of the managed investment trust will then be assessed on the share under section 99A of the ITAA 1936. The purpose of this is to deter trustees from accumulating income within the managed investment trust. [Schedule 10, item 6, section 99H of the ITAA 1936]

Beneficiaries under a legal disability

11.64 Where a beneficiary is under a legal disability, the trustee will be liable to tax under subsection 98(1) of the ITAA 1936. Section 100 of the ITAA 1936 operates to ensure that beneficiaries under a legal disability are also assessed on their share of income of the trust estate with a credit for any tax paid by the trustee. However, section 100, as a general rule, only applies where the beneficiary is a beneficiary in more than one trust estate or also derives income from another source. To prevent double taxation, the operation of section 100 has been extended to cover the situation where part of the net income of a non-resident beneficiary is reasonably attributable to a payment from which an amount was required to be withheld under this measure. [Schedule 10, item 7, subsection 100(1C) of the ITAA 1936]

Deemed quotation of a tax file number withholding where withholding has been made

11.65 Section 202EE of the ITAA 1936 provides that a tax file number is deemed to have been quoted by a non-resident in relation to certain investments. The section is amended to include in the category of non-residents who are deemed to have quoted a tax file number those taxpayers receiving payments from which an investment body is required to withhold under the new managed fund withholding provisions. [Schedule 10, item 8]

Deemed quotation of a tax file number withholding where withholding has been made under Subdivision 12-H

11.66 Section 255 of the ITAA 1936 provides that the Commissioner may require a person receiving money on behalf of a non-resident to pay the income tax payable by the non-resident. The section is amended to exclude from the operation of the section money due to a non-resident from which amounts must be withheld under Subdivision 12-H. [Schedule 10, item 9]

Consequential changes to the TAA 1953

11.67 Section 10-1 of Schedule 1 to the TAA 1953 summarises in a table the payments subject to PAYG withholding. The table is amended to list two new withholding payments as specified in sections 12-385 and 12-390. [Schedule 10, item 14]

11.68 Section 12-5 of Schedule 1 prescribes the priority with which particular PAYG withholding provisions are to be applied if more than one withholding provision covers a payment. The new withholding arrangements for managed investment trust payments are to be applied in priority to all other withholding provisions. A new item has been inserted into the table in subsection 12-5(2) to specify this priority. [Schedule 10, item 15]

11.69 Section 15-15 of Schedule 1 provides that the Commissioner may vary the amount required to be withheld from a withholding payment. These variation rules will not apply to the new withholding arrangements for managed investment trusts, trustee intermediaries and agent intermediaries as the standard rate of withholding will be the company tax rate. It is intended that this rate will apply to all payments subject to these new withholding arrangements. [Schedule 10, items 16 to 18]

11.70 Entities required to withhold under the new withholding arrangements are required to report to the Commissioner on the amounts withheld on an annual basis. The time of the report is later than the standard annual report under PAYG withholding as payments that are subject to withholding may be made after the end of a year. The reports will be required to be given to the Commissioner not later than 14 days after the end of six months after the end of the income year of the managed investment trust or within a longer period allowed by the Commissioner. The longer period for reporting reflects the extension of time that the Commissioner may grant for making fund payments. [Schedule 10, item 19, subsection 16-153(4 )]

11.71 Entities required to withhold under the new arrangements will be required to provide a statement each year to the payees. The statement must detail the amounts of the payments from which withholding has occurred and the amounts withheld from those payments. The statement must be provided within 14 days after the end of six months after the end of the managed investment trust's income year. The statement may be provided in electronic form and a copy will not be required to be given to the payee. The standard payment summary rules do not apply to the new withholding arrangements. Instead, specific payment summary requirements apply to managed investment trust payments. [Schedule 10, items 20 to 24]

11.72 The existing penalty for failure to provide a payment summary will be extended so that it applies where a payer fails to supply a payment summary as required under the amendments in this Schedule. Extending the existing penalty ensures that the same penalty applies for failure to provide a payment summary under both existing and the new withholding regimes. [Schedule 10, items 25 and 26]

11.73 It will be an offence to claim a credit for an amount withheld under the new managed fund withholding provisions by providing a statement that has not been duly provided to the taxpayer. Section 20-35 is amended to apply this offence to the managed fund withholding rules. [Schedule 10, items 29 to 31]

REGULATION IMPACT STATEMENT

Policy objective

11.74 The purpose of this measure is to improve the efficiency of the managed funds industry in respect of the collection of tax from distributions to foreign residents.

11.75 This measure implements the Government's decision announced in the Treasurer's Press Release No. 39 of 9 May 2006 to simplify the tax collection mechanism for taxable income distributed to foreign residents by Australian managed funds (and custodians which are an integral part of this industry). This was one of several changes to the tax arrangements for trusts designed to clarify obligations and reduce reporting requirements while maintaining the integrity of the system.

The objectives of this measure

11.76 This measure aims to provide certainty and simplicity for both the managed funds industry and the Australian Taxation Office (ATO) on how tax should be collected from distributions of Australian source income, other than dividends, interest or royalties, by Australian managed funds to foreign residents (including distributions made through Australian intermediaries).

Implementation options

11.77 This measure is the result of the complexity that would otherwise have occurred as a result of different tax outcomes depending upon whether the foreign residents were an individual, company, trustee or superannuation fund. Because of the common use of custodian, nominees and other intermediaries, Australian managed investment trusts and Australian intermediaries are unlikely to know these details. Accordingly, they would not be able to manage their obligation to withhold tax effectively.

11.78 As a result of this measure, there would be one withholding outcome for distributions of income (other than dividend, interest and royalty income) by Australian managed investment trusts and Australian intermediaries - withholding at the company tax rate - regardless of whether the foreign resident is an individual, company, trustee or foreign superannuation fund.

Assessment of impacts

11.79 The potential compliance, administration and economic impacts of this measure are likely to be as follows.

Impact group identification

11.80 The main groups to be affected by this measure are Australian managed investment trusts (particularly Australian property trusts) and Australian intermediaries. It is estimated that there are around 50 entities that would meet the definition of 'intermediary', and around 4,000 entities that would meet the definition of 'managed investment trust'.

11.81 In turn, their clients would also be affected. These are entities such as foreign resident individuals, foreign resident companies (hedge funds, financial institutions such as banks and life insurance companies), foreign resident superannuation funds (assessable as non-complying funds) and other foreign resident trusts (includes foreign or global custodians and potentially other nominee entities).

Analysis of costs and benefits

Compliance costs

11.82 This measure is estimated to involve medium costs in relation to once-off implementation of systems changes, and a small ongoing cost to manage ongoing record keeping and information collection obligations for Australian managed funds and custodians. Against this, this measure will reduce compliance costs by removing any need for these entities to ascertain whether the foreign resident investor is an individual, company, trustee or foreign pension fund in determining their withholding obligations, and any doubt about whether the correct rate of withholding is made.

Administration costs

11.83 It is estimated that there will be a small administrative impact on the ATO. In particular, it is estimated that there will be minimal impact upon the creation of interpretation and information products (products which assist in the interpretation and understanding of the law, respectively), and low impact on active compliance products (activities that maximise compliance).

Government revenue

11.84 This measure will have these revenue implications:

2007-08 2008-09 2009-10 2010-11
$10m $15m $15m $15m

Economic benefits

11.85 This measure will remove the need for managed investment trusts and intermediaries from having to classify the nature of the foreign investor as individual, company, trustee or foreign superannuation fund. Consequently, the measure will also reduce the uncertainty regarding the obligations of managed investment trusts and intermediaries to withhold amounts from distributions to foreign residents. This in turn would improve Australian property trusts as a destination for foreign capital.

11.86 These compliance cost savings and reduced uncertainty would have the effect of increasing the efficiency of the Australian managed funds industry in providing funds management services to foreign residents. This results in a greater ability of the Australian managed funds industry to compete against foreign managed fund industries for the management of the investment of foreign residents' savings.

Consultation

11.87 Business, legal and accounting representatives and the ATO have been consulted extensively and have actively assisted in developing this measure. The more technical issues and the details of the measure were considered on a confidential basis by a working group of representatives from the following bodies:

·
Investment and Financial Services Association;
·
Australian Custodial Services Association;
·
Tax Institute of Australia;
·
Institute of Chartered Accountants in Australia; and
·
Property Council of Australia.

11.88 Meetings took place in November 2006 and March 2007. The main aspects of the measure covered included the definitions of 'managed investment trust', 'trustee intermediary' and 'agent intermediary', as well as the determination of amounts upon which withholding would be made.

11.89 Suggestions made by representatives on the legislative details of this measure were adopted where consistent with the policy objectives and the integrity of this measure.

11.90 The consultation group has been supportive of the consultation process.

Conclusion

11.91 This measure would provide the Australian property trust sector with compliance savings by having a single rate applied to distributions to different types of entities. This reduces compliance costs associated with tracing different types of income and different types of recipients of that income.

11.92 Treasury and the ATO will monitor this taxation measure, as part of the whole taxation system, on an ongoing basis.


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