House of Representatives

Explanatory Memorandum

Circulated by the authority of the Treasurer, the Hon Wayne Swan MP

Chapter 1 - Distributions of managed investment trust income to foreign residents

Outline of chapter

1.1 Schedule 1 to this Bill inserts Division 840 and Subdivision 840-M into the Income Tax Assessment Act 1997 (ITAA 1997).

1.2 This Schedule:

•

replaces the current Subdivision 12-H of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) dealing with the obligations to withhold amounts;

•

inserts, into a new Division 840 in both the ITAA 1997 and the Income Tax (Transitional Provisions) Act 1997 (IT (TP) Act 1997), Subdivision 840-M dealing with managed investment trust withholding tax as a final withholding tax; and

•

repeals and amends various other provisions of the ITAA 1997, the TAA 1953, the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Act 1986 .

1.3 The formal imposition of income tax, and the establishment of the applicable rate of tax, is provided for by means of the Income Tax (Managed Investment Trust Withholding Tax) Bill 2008 and the Income Tax (Managed Investment Trust Transitional) Bill 2008.

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

Context of amendments

1.5 The Australian funds managed industry has assets under management of approximately $1.4 trillion. This makes it one of the largest markets for managed funds in the world. The industry is expected to continue its growth, with funds under management forecast to exceed $2.5 trillion by 2015.

1.6 At present, less than 3 per cent of the fees derived by the Australian funds management industry are attributable to foreign investment. Industry has contended this is due, in part, to the high withholding tax that currently applies to certain distributions from the industry to foreign investors, namely, the 30 per cent non-final withholding rate that predominantly applies to distributions of Australian source rental income and capital gains from Australian property trusts.

1.7 Industry argues the headline rate of withholding discourages foreign investment in the Australian funds management industry as it is higher, on average, than the withholding tax rates imposed by other countries, particularly those in the Asia-Pacific region.

1.8 The Government, in furthering its objective to secure Australia's position as a financial services hub in the Asia-Pacific region, will replace the existing non-final withholding regime with a new final withholding tax regime with reduced withholding tax rates, to be implemented over a three-year period. Once fully implemented, foreign investors of jurisdictions with which Australia has effective exchange of information on tax matters will be subject to a 7.5 per cent final withholding tax, which will be one of the lowest internationally. This will enhance the competitiveness of the industry and ensure it is well-placed to attract and retain foreign investment.

1.9 Subjecting residents of jurisdictions with which Australia does not have effective exchange of information to a 30 per cent final withholding tax will enhance the integrity of the new arrangements and send a strong signal of Australia's non-tolerance of international tax evasion and avoidance.

Summary of new law

1.10 This Schedule implements a new withholding tax regime in respect of certain distributions from managed investment trusts to foreign residents.

1.11 The new withholding tax regime, in respect of these distributions replaces the existing 30 per cent non-final withholding regime, with effect for fund payments made in relation to the first income year starting on or after the first 1 July following Royal Assent. A 'fund payment' is, broadly, a component of a payment made by a managed investment trust that represents a distribution of Australian source net income (other than dividends, interest and royalties) of the trust.

1.12 An entity may have an obligation to withhold an amount from a fund payment, or an amount reasonably attributable to a fund payment, where it on-pays to a recipient (or, in certain cases, the recipient becomes entitled to the amount) and the place of payment or address of the recipient is outside Australia (or, in certain cases, the recipient is a foreign resident).

1.13 Where an entity is in receipt of an amount that is, or reasonably attributable to, a fund payment and is not required to withhold, it may be required to give a notice or make available on a website certain details of the on-payment that another entity can use in discharging its obligations.

1.14 The rate of withholding is determined with regard to the place of payment or address of the recipient (or, in some cases, the residency of the recipient). If the place, address or country of residence is in a jurisdiction with which Australia has effective exchange of information on tax matters, withholding will be required at the following rate:

•

22.5 per cent for fund payments in relation to the first income year following Royal Assent;

•

15 per cent for fund payments in relation to the second income year; and

•

7.5 per cent for fund payments in relation to later income years.

1.15 In any other case, withholding will be required at the rate of 30 per cent.

1.16 A foreign resident investor will have a liability to managed investment trust withholding tax in respect of amounts represented by or reasonably attributable to fund payments where these amounts are paid to the foreign resident or (in certain cases) the foreign resident is presently entitled to the amounts.

1.17 For a foreign investor liable to managed investment trust withholding tax, the rate of tax depends on their residency status. Where the foreign investor is resident in a jurisdiction with which Australia has effective exchange of information, the taxation treatment will be as follows:

•

for fund payments in relation to the first income year of application - the foreign investor will be subject to tax at a new rate of 22.5 per cent on fund payments, net of related deductions (as an interim measure);

•

for fund payments in relation to the second income year - the foreign investor will be subject to a 15 per cent final withholding tax; and

•

for fund payments in relation to later income years - the foreign investor will be subject to a 7.5 per cent final withholding tax.

1.18 In any other case, a 30 per cent final withholding tax will apply.

Comparison of key features of new law and current law

Detailed explanation of new law

Obligations under the new withholding regime

1.19 All obligations to withhold under the new withholding regime rely on there being an initial distribution of certain amounts (of, broadly speaking, Australian source net income other than dividends, interest and royalties) from a managed investment trust. The obligation to withhold may arise at the time the managed investment trust makes the payment. If the managed investment trust does not have an obligation to withhold at that time, it may have an obligation to give a notice to the recipient or make certain information available on a website in respect of the payment.

1.20 The giving of a notice or publication of information on a website in relation to a payment may trigger an obligation on the recipient of the payment to withhold an amount when on-paying to a third entity. Alternatively, it may trigger an obligation to provide a notice to the third entity or publish information on a website in relation to the on-payment. The obligation to give a notice or make information available on a website will continue through a chain of entities until the obligation to withhold is triggered. [Schedule 1, item 1, section 12-375]

Obligation of a managed investment trust to withhold in respect of certain payments

1.21 Two requirements must be satisfied before there is an obligation on a trust which is a managed investment trust, in relation to a particular year, to withhold an amount from a payment it makes in relation to that year. These are:

•

the payment must be, in whole or part, a fund payment; and

•

the recipient of the payment must have a relevant connection outside Australia.

[Schedule 1, item 1, subsection 12-385(1)]

What is a managed investment trust ?

1.22 While the existing Subdivision 12-H is being repealed, the new Subdivision 12-H inserted by these rules contains a definition of 'managed investment trust' that is broadly consistent with the definition in the current law.

Testing at the time of the first fund payment

1.23 Consistent with the existing definition, the relevant time for determining whether a trust is a managed investment trust for a year of income is the time of the making of the first 'fund payment'. [Schedule 1, item 1, paragraph 12-400(1)(a)]

1.24 Where the relevant conditions (set out below) are satisfied at the time of making the first fund payment in relation to an income year, the trust will be a managed investment trust for the entire year of income, notwithstanding that the conditions may not be satisfied at a later time in the income year. This provides certainty to investors and other interposed entities receiving distributions from the trust during the income year as to whether the payments will be subject to withholding during the income year.

1.25 A trust is a managed investment trust in relation to an income year where all the following conditions are satisfied at the time the first fund payment in relation to the income year is made:

•

the trust has a relevant connection with Australia (at the time of the first fund payment or at an earlier time in the income year);

•

the trust must satisfy certain requirements of the Corporations Act 2001 (Corporations Act) pertaining to the management of investments; and

•

the trust is either listed or widely held.

[Schedule 1, item 1, subsections 12-400(1) and (2)]

Connection with Australia

1.26 The connection with Australia can be established in one of two ways. First, a trustee of the trust can be an Australian resident [Schedule 1, item 1, item 1(a) in the table in paragraph 12-400(1)(b)] . Where there are multiple trustees, the connection with Australia is satisfied if any one of those trustees is an Australian resident. This represents a change to the requirements applying under the existing rules.

1.27 Second, and alternatively, the trust's central management and control can be located in Australia. [Schedule 1, item 1, item 1(b) in the table in paragraph 12-400(1)(b)]

1.28 In either instance, the connection must exist at some time during the income year up to and including the time of making the first fund payment.

1.29 These tests broadly align with the residency test for trusts set out in Division 6 of Part III of the ITAA 1936.

Corporations Act 2001 requirements to manage investments

1.30 A trust must be associated with the management of investments as regulated by the Corporations Act to be a managed investment trust. This means, at the time of making the first fund payment, the trust must be a 'managed investment scheme' 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. [Schedule 1, item 1, item 2 in the table in paragraph 12-400(1)(b)]

1.31 This requirement ensures the trust is a genuine collective investment vehicle. It limits the ability of foreign residents to establish trust structures as a means by which to access the withholding tax rates.

Listed or widely held requirement

1.32 The trust must be listed or widely held at the time of making the first fund payment for the income year. This requirement is satisfied if:

•

the units of the trust are listed on an approved stock exchange in Australia;

•

the trust has at least 50 members (other than objects of a trust); or

•

the trust has less than 50 members but one of the members is an entity of a type specified in the rules.

[Schedule 1, item 1, item 3 in the table in paragraph 12-400(1)(b)]

1.33 A trust would not be held to have at least 50 members where the purported members of the trust are discretionary objects. Without this rule, a person could establish a trust that purports to be widely held (by having more than 50 discretionary beneficiaries) but which is not widely held as a matter of substance. This would defeat the policy objectives of the new rules.

1.34 A trust will be considered widely held if, although it has less than 50 members, one of the members of the trust is an entity of a specified kind. The entities specified in the new rules are:

•

a life insurance company;

•

a complying superannuation fund, complying approved deposit fund, or a foreign superannuation fund, as long as the fund has at least 50 members;

•

an Australian resident trust that is a managed investment scheme operated by a financial services licensee whose licence covers operating such a scheme and that is listed on an approved stock exchange or has at least 50 members (other than objects of the trust); and

•

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

[Schedule 1, item 1, subsection 12-400(2)]

1.35 The types of entities listed above typically hold investments collectively.

1.36 The rules provide for tracing through one or more interposed trusts where an entity that owns directly or holds indirectly the interests of the trust is of a type specified in the list above. However, it must be the case that each interposed trust is an Australian resident trust that is a managed investment scheme operated by a financial services licensee with a licence that covers operating a managed investment scheme.

1.37 The tracing rule recognises that a managed investment scheme established by a wholesale trust would otherwise fail to satisfy the test of being widely held, even if interests in the wholesale trust were held by entities with more than 50 members.

Example 1.1

Zoidberg Trust is a managed investment scheme that is operated by a financial services licensee whose licence covers operating such a scheme. Zoidberg Trust has a trustee that is an Australian resident. It is not listed on an approved stock exchange in Australia and has one member.

Interests in Zoidberg Trust are held by Fry Trust, a trust whose central management and control is in Australia. Fry Trust is also a managed investment scheme operated by a financial services licensee whose licence covers operating such a scheme. Fry Trust has three members.

One of the three members of Fry Trust is Leela Superannuation Fund, a complying superannuation fund that has at least 1,000 members.

Zoidberg Trust will satisfy the requirement of being widely held. Although it only has one member, that member, Fry Trust, is a trust whose central management and control is in Australia, and is a managed investment scheme, interests in which are directly owned by an entity of the kind specified in the rules, being a complying superannuation fund (Leela Superannuation Fund).

1.38 Under the tracing rule, interests in the trust purporting to be a managed investment trust must be owned directly or held indirectly by an entity of a kind specified in the rules. The tracing rule cannot be satisfied by tracing through to two or more entities that, in aggregate, have 50 or more members.

Example 1.2

Assume the same facts as in Example 1.1 except that Fry Trust has the following members:

•

Leela Superannuation Fund, a complying superannuation fund with 40 members; and

•

Farnsworth Trust, an entity with a similar status to a managed investment scheme regulated under UK law with 35 members.

In this case, interests in Fry Trust would not be owned by one entity of a kind specified in the rules that has 50 or more members (or is listed on an approved stock exchange in Australia).

Consequently, Zoidberg Trust will fail to satisfy the widely held requirement. This is so despite the fact that Leela Superannuation Fund and Farnsworth Trust together have more than 50 members.

An exception if a foreign resident individual has a substantial interest in the trust

1.39 A trust is taken not to be widely held if any one foreign resident individual directly or indirectly:

•

holds, or has the right to acquire, interests representing 10 per cent of more of the value of the interests in the trust;

•

has the control of, or ability to control, 10 per cent or more of the rights attaching to 'membership interests' (as defined in section 960-135 of the ITAA 1997) in the trust; or

•

has the right to receive 10 per cent or more of any distribution of income that the trustee may make.

[Schedule 1, item 1, subsection 12-400(3)]

1.40 Where one of the conditions set out above is satisfied, the trust will not qualify as a managed investment trust. This result is consistent with the policy intent of the new rules, which is to encourage collective investment in widely held trusts.

Special rules for trusts that are created or cease to exist during an income year

1.41 The requirement that a managed investment trust be listed or widely held may be difficult to satisfy in the income year in which the trust is starting up or winding up. For this reason, there are special rules that require a trust to satisfy only the requirements of:

•

being an Australian resident trust; and

•

a managed investment scheme operated by a financial services licensee whose licence covers operating such a scheme,

in the start-up or wind-up year.

[Schedule 1, item 1, subsections 12-400(4) and (5)]

1.42 The rules do not allow a trust to qualify as a managed investment trust for two successive income years by utilising the start-up phase in the first year and wind-up phase in the following year. This is because each exception to the widely held requirement is specifically targeted and not intended to be used in conjunction. To allow otherwise would be inconsistent with the broad aim of the new rules, which is to encourage long-term investment by foreign residents.

What payments does a managed investment trust have to withhold from ?

1.43 The new withholding regime applies to amounts that represent or are reasonably attributable to fund payments made by a managed investment trust to certain recipients. While the existing Subdivision 12-H is being repealed, the new Subdivision 12-H inserted by this Schedule contains a definition of 'fund payment' broadly consistent with the definition of the term in the current law. The main difference is the new definition treats capital losses from taxable Australian property as 'excluded amounts', consistent with the treatment of capital gains. [Schedule 1, item 1, paragraph 12-405(1)(d)]

1.44 The rules do not apply to fund payments in relation to an income year by a trust that is not a managed investment trust in relation to that income year. Further discussion can be found in paragraphs 1.63 and 1.64.

What is a fund payment ?

1.45 The fund payment component of a payment made by the trustee of a managed investment trust is that portion of the payment that represents, in effect, a distribution of the net income of the trust (disregarding certain amounts, known as excluded amounts, and related deductions) such that the total of the fund payments made by the trust in relation to an income year equals, as nearly as practicable, the net income of the trust (suitably adjusted) for the year. [Schedule 1, item 1, subsection 12-405(1)]

1.46 In order to assist a trustee in working out how much of a payment made by the trustee is a fund payment, consistent with the current rules in Subdivision 12-H which is being repealed, the new rules set out a three-step process in the form of a method statement.

1.47 This process requires estimation, at the time of payment, of the adjusted net income of the trust and other fund payments in relation to the income year expected to be made by the trust.

Step 1 - Amounts excluded from the calculation

1.48 Step 1 of the method statement involves reducing the amount of the actual payment made, by the portion of the payment attributable to 'excluded amounts' being:

•

dividend, interest or royalty income, subject to (or exempted from) withholding tax under Division 11A of Part III of the ITAA 1936;

•

any capital gains or capital losses from CGT events that happen in relation to CGT assets that are not taxable Australian property; or

•

amounts not from an Australian source.

[Schedule 1, item 1, step 1 in the method statement in subsection 12-405(2)]

1.49 Excluded amounts represent items of income that would generally not be assessable to a foreign resident or that are subject to separate withholding tax arrangements (or made exempt from such arrangements).

1.50 It is intended the rules that set out excluded amounts be applied cumulatively. For example, if a capital gain from a CGT event happens in relation to a CGT asset that is taxable Australian property, it cannot be disregarded if it constitutes an amount that is not from an Australian source.

1.51 The new definition of 'fund payment' extends the definition of 'excluded amounts' to include a capital loss from a CGT event that happens in relation to a CGT asset that is not taxable Australian property [Schedule 1, item 1, paragraph 12-405(1)(d)] . This contrasts with the position under the current Subdivision 12-H, which did not identify a capital loss from a CGT event happening in relation to a CGT asset that is not taxable Australian property, to be an excluded amount. As excluded amounts represent items of income that would, generally, not be assessable to a foreign resident, it is appropriate to exclude both capital gains and capital losses from CGT events that happen in relation to such CGT assets.

Step 2 - Estimating the adjusted net income of the trust

1.52 Under step 2 of the method statement, the trustee must 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 year in relation to which the payment is made, disregarding expected excluded amounts and related deductions. [Schedule 1, item 1, paragraph (a) of step 2 in the method statement in subsection 12-405(2) and subsection 12-405(3)]

1.53 The process of determining a reasonable estimate of the net income of the trust is necessitated by the fact a trust's net income is an amount that can only be ascertained at the end of the trust's income year.

1.54 Excluded amounts are disregarded under step 2 of the method statement for the same reasons they are disregarded under step 1 of the method statement.

1.55 Under step 2 of the method statement, the trustee 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 1, item 1, paragraph (b) of step 2 in the method statement in subsection 12-405(2)]

Step 3 - Ascertaining how much of a payment is a fund payment

1.56 The third and final step in ascertaining how much of a payment is a fund payment involves a determination 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 actual payment reduced by excluded amounts;

•

the amounts of any earlier fund payments made in relation to the income year; and

•

expected amounts of any later fund payments to be made based on the trustee's knowledge at the time payment is made.

[Schedule 1, item 1, step 3 in the method statement in subsection 12-405(2)]

1.57 Whether it is reasonable to conclude a specific portion of the payment is a fund payment is to be determined on an objective basis. The test is whether a reasonable person would consider 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 1.3

The Hoffman Managed Fund, a managed investment trust, makes two distributions per annum. At the time of its second 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 Dec ( Already paid )	Jan to June ( Current payment )	Total
Dividends from Australian company ( A )	$200	$800	$1,000
Australian source rental income ( B )	$250	$350	$600
Expenses related to Australian source rental income ( C )	($0)	($300)	($300)
Capital gains from CGT events happening to CGT assets that are taxable Australian property (not eligible for discount) ( D )	$0	$650	$650
Capital losses from CGT events happening to CGT assets that are not taxable Australian property ( E )	$0	($500)	($500)
Other distributable amounts (eg, tax preferred amounts) ( F )	$100	$350	$450
Total ( G = A + B - C + D + E + F )	$550	$1,350	$ 1 , 900
Total (net of excluded amounts) ( H = G - A - E )	$350	$1,050	$ 1 , 400
Estimated net income (I )	$450	$1,000	$ 1 , 450
Estimated adjusted net income (net of excluded amounts) ( J = I - A - E )	$250	$700	$ 950

At the time of the Fund's second distribution, it decides to pay an amount of $1,350. The trustee of the Hoffman Managed Fund is required to determine, based on its knowledge at the time of the second distribution, how much of the payment of $1,350 is a fund payment. This is done as follows:

Step 1: The amount of the payment net of 'excluded amounts' (being the $800 of dividend income and the capital loss of $500, which relates to a CGT event happening to a CGT asset that is not taxable Australian property) is $1,050.

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, will be $950.

Step 3: The trustee must determine how much of the step 2 amount is a fund payment having regard to:

•

the object of section 12-405 (which is, that the total of the fund payments that the trustee makes in relation to an income year equals, as nearly as practicable, the net income of the trust for the income year, disregarding excluded amounts). The expected adjusted net income of the trust, at the time the second and final distribution is made, is $950;

•

the step 1 amount, which is $1,050; and

•

the amount of any earlier fund payments made during the income year. This was $350.

As the expected adjusted net income of the trust, at the time the second and final distribution is made, is $950, and the trustee had previously made a fund payment of $350, the trustee could designate that, of the second distribution being made, $600 is the fund payment.

Time limits on when the fund payment must be made

1.58 A payment will not be a fund payment in relation to an income year unless it is paid:

•

during the income year;

•

within three months after the end of the income year; or

•

within a longer period as allowed by the Commissioner of Taxation (Commissioner), but not exceeding six months from the end of the income year.

[Schedule 1, item 1, subsections 12-405(4) and (5)]

1.59 The requirement that all fund payments be made within a specified period of time following the end of the year of income ensures there is timely collection of withholding amounts (as an obligation on the managed investment trust to withhold is triggered by payment to certain recipients).

1.60 Managed investment trusts are allowed a period of three months from the end of the income year within which to make fund payments relating to that year without requiring an exercise of the Commissioner's discretion, in recognition of the fact they will typically require that period of time in order to ascertain their net income for the year.

1.61 If the Commissioner is of the opinion a trustee of a managed investment trust was unable to make a fund payment within the three-month period because of circumstances beyond the influence or control of the trustee, the Commissioner may extend the period within which the fund payment must be paid, although the period can be extended by no more than six months following the end of the year of income. [Schedule 1, item 1, subsection 12-405(5)]

1.62 An example of a circumstance where an extension of the time period may be warranted is where an unrelated trust, in which the trustee of the managed investment trust had 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 obtain that information. Without this information, the managed investment trust is unable to accurately calculate its net income.

Fund payment must be in relation to an income year

1.63 To come within the operation of the managed investment trust withholding regime implemented by this Schedule, the fund payment made by a managed investment trust must relate to an income year in which the trust was a managed investment trust [Schedule 1, item 1, subsection 12-385(1)] . A trust that is a public trading trust or corporate unit trust cannot be a managed investment trust [Schedule 1, items 9 and 11, subsections 102L(15) and 102T(16) of the ITAA 1936].

1.64 It is possible a trust that is a managed investment trust for the current year, but was not for the prior year, may make a payment, in the current year, of part of its prior year Australian source net income (net of excluded amounts and related deductions). Although such a payment will constitute a fund payment, because it relates to an income year in which the trust was not a managed investment trust, withholding will not be required under these rules. However, other provisions of the income tax law may apply to bring to tax the relevant share of net income (eg, section 98 of the ITAA 1936).

Example 1.4

Lee Trust is a managed investment trust for the 2009-10 income year, but was not a managed investment trust for the 2008-09 income year. For the 2008-09 income year, Lee Trust derived a net capital gain from taxable Australian property (that was not eligible for the CGT discount) of $20,000. The trustee of Lee Trust estimates the trust will derive Australian source rental income (net of related expenses) of $10,000 for the 2009-10 income year.

Katrina is a foreign resident beneficiary of the Lee Trust. She is not a beneficiary in the capacity of trustee of another trust.

Lee Trust makes a payment to Katrina's UK bank account of $300 on 15 August 2009. Of this amount, $200 is identified as relating to the 2008-09 income year and $100 to the 2009-10 income year. Both amounts represent a part of the net income of the trust, net of excluded amounts and related deductions. Therefore, $200 of the payment is a fund payment relating to the 2008-09 income year and $100 of the payment is a fund payment relating to the 2009-10 income year.

The trustee of Lee Trust will only be required to withhold from the fund payment of $100 as this is a fund payment that relates to an income year in which the trust was a managed investment trust. Lee Trust will not be required to withhold from the fund payment of $200.

However, if Katrina was a foreign resident for the 2008-09 income year, presently entitled to a share of the income of the Lee Trust for the 2008-09 income year represented by or reasonably attributable to the fund payment, the trustee of Lee Trust would be liable to tax on that share of the net income of the trust for the 2008-09 income year under section 98 of the ITAA 1936.

Displacement of agency rule

1.65 Consistent with current Subdivision 12-H, the new withholding regime implemented by this Schedule contains rules with specific application to agents. For the purpose of the new Subdivision 12-H, where an interposed entity is acting as an agent of a foreign resident, a payment from a managed investment trust to the interposed entity will be taken not to be a payment to an agent of the foreign resident and, by implication, not a payment to the foreign resident as principal. Any advance by the interposed entity to the foreign resident will also be treated as if it were a payment made by the interposed entity to the foreign resident. [Schedule 1, item 1, section 12-420]

1.66 From the perspective of the managed investment trust, the design of the rules is such that the withholding obligation of the trust is unaffected by whether the interposed entity is, or is not, an agent of the foreign resident. As such, the managed investment trust does not need to know the capacity in which the interposed entity is acting in order to correctly determine its own obligations under Subdivision 12-H.

What entity must receive the payment ?

1.67 The new rules implemented by this Schedule provide that withholding is required by a managed investment trust if an amount representing a fund payment is made to an entity with a relevant connection outside Australia. A recipient will have a relevant connection outside Australia if either:

•

according to any record in the payer's (the managed investment trust's) possession, or kept or maintained on their behalf, the recipient has an address outside Australia; or

•

the payer is authorised to make payment at a place outside Australia.

[Schedule 1, item 1, subsection 12-410(1)]

1.68 The new rules recognise that a managed investment trust often does not have sufficient information to determine whether the recipient is a foreign resident for Australian tax purposes and, accordingly, focuses attention on whether the recipient has provided an address to the payer that is an overseas address or has authorised the payer to make payment at a place outside Australia. The new rules are consistent with certain provisions of Subdivision 12-F (which sets out the withholding obligations in respect of dividends, interest and royalties), which require withholding in respect of payments to 'overseas persons', based on the address of the recipient and the place where payment is made.

1.69 It is possible that a recipient may provide the managed investment trust with more than one address. If one of those addresses is outside Australia, the recipient will have a relevant connection outside Australia.

1.70 A recipient will not be considered to have a relevant connection outside Australia if the recipient is carrying on business at or through an Australian permanent establishment and the amount received from the managed investment trust is attributable to that permanent establishment. [Schedule 1, item 1, subsection 12-410(2)]

1.71 In such cases, the recipient (not the managed investment trust) may have an obligation to withhold. Imposing the obligation to withhold in such cases on the recipient and not the managed investment trust minimises the chances withholding will occur where it should not (eg, because the ultimate recipient of the payment is an Australian resident and, therefore, there is no underlying liability to managed investment trust withholding tax).

1.72 If all the requirements for withholding by the managed investment trust are met except for the fact the recipient has a relevant connection outside Australia, the managed investment trust must issue a notice to the recipient or publish on a website certain details in respect of the payment [Schedule 1, item 1, subsections 12-395(1) and (2)] . This obligation is discussed in paragraphs 1.80 to 1.92.

Amount of withholding required

1.73 Where the managed investment trust has an address for the recipient in its records (or on records maintained on its behalf), or has been authorised to make payment to, a jurisdiction that is listed in the regulations as an 'information exchange country', withholding will be required on the amount of the fund payment at the following rate:

•

22.5 per cent for fund payments in relation to the first income year starting on or after the first 1 July after the day on which Royal Assent is received for these amendments;

•

15 per cent for fund payments in relation to the second income year starting on or after the first 1 July after the day on which Royal Assent is received for these amendments;

•

7.5 per cent for fund payments in relation to the third and later income years starting on or after the first 1 July after the day on which Royal Assent is received for these amendments.

[Schedule 1, item 1, paragraph 12-385(3)(a) and subsection 12-385(4)]

1.74 The rate of withholding, in any other case, is 30 per cent. [Schedule 1, item 1, paragraph 12-385(3)(b)]

1.75 The distinction made between an 'information exchange country' and any other country is consistent with the requirement to determine whether a foreign resident is a resident of an 'information exchange country' or not for the purposes of determining what rate of tax is applicable to the liability to managed investment trust withholding tax.

When is withholding not required ?

1.76 An obligation to withhold from a payment, a portion of which is a fund payment, will not arise to the extent there is no underlying liability for managed investment trust withholding tax on the payment or on an amount reasonably attributable to the payment. [Schedule 1, item 1, subsection 12-385(5)]

1.77 This result is similar to that achieved by section 12-300 in the context of Subdivision 12-F (concerning dividends, interest and royalties).

Example 1.5

The Burns Trust, a managed investment trust, is making a payment to Wayne Smithers, a US citizen. Wayne has resided in Australia for a number of years but has always requested payment be made to his US bank account. He is an Australian resident for tax purposes.

The Burns Trust makes a payment of $800, of which $300 represents a dividend and $500 represents a fund payment. As Wayne is not a foreign resident, he does not have a withholding tax liability in respect of either the dividend or the fund payment. Therefore, the Burns Trust is not required to withhold from either payment.

Wayne Smithers will have a liability to income tax under section 97 of the ITAA 1936, being a resident presently entitled to the net income of the Burns Trust.

1.78 A managed investment trust may be unaware that no managed investment trust withholding tax is payable and may, consequently, withhold from the payment when withholding is not required at law. This will arise because the trust is unaware of the exact circumstances of the person to whom payment is being made.

1.79 In such circumstances, an amount has been withheld in error. Accordingly, the person that has borne the withholding amount without an underlying withholding tax liability could seek a refund from the managed investment trust of the amount erroneously withheld under section 18-65. Where the conditions for refund under section 18-65 are not met, the recipient may apply to the Commissioner for a refund under section 18-70.

Obligations of a managed investment trust to give a notice or make information available on a website

1.80 Where a managed investment trust is not required to withhold from a payment, the managed investment trust may have an obligation to give a notice or publish information on a website in respect of the payment.

1.81 The obligation to give a notice or make information available on a website will arise where the following conditions are satisfied:

•

the managed investment trust makes a payment;

•

had the payment been made to an entity with a relevant connection outside Australia, withholding would have been required; and

•

withholding is not required because payment was not made to such an entity.

[Schedule 1, item 1, subsection 12-395(1)]

1.82 A managed investment trust is only required to give a notice or make information available on a website where all conditions for withholding are satisfied except for the condition that the recipient have a connection outside Australia.

What is the purpose of the obligation to give a notice or make information available on a website ?

1.83 The purpose of the obligation to issue a notice or make information available on a website is to provide the payee with sufficient information about the payment so as to allow it to accurately discharge its withholding obligation, or obligation to issue a notice or make information available on a website (whichever is applicable).

Information that is to be provided in a notice or made available on a website

1.84 The information provided in a notice or made available on a website must specify:

•

the part or parts of the payment from which withholding is required; and

•

the income year of the managed investment trust to which each of the part(s) relate.

[Schedule 1, item 1, subsection 12-395(3)]

1.85 There may be situations where a managed investment trust makes a single payment that comprises two fund payments that relate to different income years. In such cases, the notice or information made available on the website must separately identify the two fund payments and the income years to which they relate.

Requirements that apply where information is made available on a website

1.86 There is no separate obligation on the managed investment trust to advise the recipient that information has been placed on a website. It is expected that entities with an obligation to withhold under these rules would generally be cognisant that this obligation may arise in respect of a payment received from a managed investment trust (or received through a chain of entities where the original payment was sourced from a managed investment trust) and would, therefore, seek out the information required in order to discharge their withholding obligations.

1.87 Where the managed investment trust makes information available on a website, it must make that information readily accessible, such that an entity with an obligation to withhold under these rules (or, itself, to issue a notice or make information available on a website) is able to obtain the information it requires to discharge its obligations. [Schedule 1, item 1, paragraph 12-395(2)(b)]

1.88 Information will not be considered to be 'readily accessible' if it is placed on a part of the website that is 'locked' (where access is not extended to all entities that may have a withholding or notification/publication obligation under these rules).

1.89 It is not necessary that the information be made available on a website of the managed investment trust. The requirement to make information available on a website can also be satisfied if the information is made available on the website of another entity, such as, the website of the Australian Securities Exchange.

1.90 The managed investment trust must ensure the information is made accessible for a period of at least five years from the date on which the information is made available [Schedule 1, item 1, paragraph 12-395(2)(b)] . The five-year period is consistent with existing record-keeping requirements in the law.

At what time must a notice be provided or information be made available on a website ?

1.91 The notice must be provided to the recipient or the information be made available on a website at or before the time payment is made. [Schedule 1, item 1, subsection 12-395(3)]

1.92 It is essential the relevant information be provided (either by notice or publication on a website) at this time because the recipient of the payment may be required to withhold from the payment on receipt (eg, if the recipient is a non-custodian and a foreign resident is immediately entitled to all or part of the payment received by the non-custodian).

Example 1.6

McLoughlin Trust, a managed investment trust for the 2008-09 and 2009-10 income years, makes a payment on 31 August 2009 of $3,000. Of this payment, $2,000 represents a fund payment relating to the 2008-09 income year and $1,000 represents a fund payment relating to the 2009-10 income year.

McLoughlin Trust makes a payment to Bardy Trust. McLoughlin Trust's records indicate that Bardy Trust has an Australian address and payment is made to an Australian bank account.

Had the trustee of McLoughlin Trust made the payment to an entity with an overseas address, the trustee would have been obliged to withhold an amount from the payment. Therefore, McLoughlin Trust is required to provide Bardy Trust with a notice or make information available on a website in relation to the payment at or before the time of payment.

The notice that is provided or the information that is made available on the website must specify the parts of the payment from which an amount would have been required to be withheld ($2,000 and $1,000); and the income years to which each part relates (ie, that $2,000 relates to the 2008-09 income year and $1,000 to the 2009-10 income year).

Obligations of custodians and other entities

1.93 A foreign resident may invest in a managed investment trust through an interposed entity. Currently, the majority of foreign residents invest in managed investment trusts through custodians.

Withholding obligations of custodians

What is a custodian ?

1.94 An entity is a custodian within the meaning of the new rules implemented by this Schedule if it carries on a business that predominantly consists of providing custodial or depository services. Custodial or depository services take their meaning from the Corporations Act. [Schedule 1, item 1, subsection 12-390(9)]

1.95 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.

When is a custodian required to withhold ?

1.96 A custodian is required to withhold from a payment it makes where the following conditions are satisfied:

•

the payment made by the custodian is reasonably attributable to a payment received by the custodian that was covered by a notice or information that was made available on a website; and

•

the recipient of the payment made by the custodian has a relevant connection outside Australia.

[Schedule 1, item 1, subsection 12-390(1)]

The payment made by the custodian must be reasonably attributable to a ' covered payment'

1.97 The first requirement for withholding by a custodian is that the payment made by the custodian must be reasonably attributable to a payment received by the custodian that was covered by a notice or information made available on a website.

1.98 The payment will be covered by information made available on a website where the entity that made the payment (the 'source payment') to the custodian gave a notice or made available information relating to the source payment on a website. [Schedule 1, item 1, subsection 12-395(2)]

1.99 If the payment made by the custodian is attributable to some other income derived by the custodian (eg, it arises in the context of another business conducted by the custodian), the payment is not reasonably attributable to the source payment. The payment made by the custodian must have a nexus with a payment received by the custodian that was covered by a notice or by information that was made available on a website. [Schedule 1, item 1, paragraph 12-390(1)(a)]

1.100 The notice that accompanies the payment or the information made available on the website will indicate the portion of the payment that potentially gives rise to a withholding obligation. The custodian will use this information to determine what portion of the payment it makes is subject to withholding.

1.101 The notice or information provided on the website will also specify the income year of the managed investment trust to which the portion of the payment potentially giving rise to withholding relates. The custodian will need this information in order to determine the appropriate rate of withholding.

Payment is made to a recipient with a relevant connection outside Australia

1.102 The second condition for withholding by a custodian is that:

•

the recipient has an address outside Australia, according to any record in the payer's (the custodian's) possession, or kept or maintained on their behalf; or

•

the custodian is authorised to make payment at a place outside Australia.

[Schedule 1, item 1, paragraph 12-390(1)(b)]

1.103 Paragraphs 1.67 to 1.72 provide further discussion of the above conditions.

The amount on which withholding is required

1.104 The rules for determining the amount a custodian must withhold are similar to the rules that apply where a managed investment trust makes a payment to a recipient with a relevant connection outside Australia. However, whereas the managed investment trust withholds an amount from that portion of the payment it makes that is a fund payment, the custodian will withhold from that portion of the payment it makes that is reasonably attributable to a fund payment that is covered by a notice or by information made available from a website. This is referred to as the 'covered part'. [Schedule 1, item 1, subsection 12-390(2)]

1.105 The withholding rates that apply under the new withholding regime are the same as those that apply to payments made by a managed investment trust [Schedule 1, item 1, subsection 12-390(3)] . The rates are specified in paragraphs 1.73 to 1.75.

When is withholding not required by a custodian ?

1.106 There are two exceptions to the obligations of a custodian to withhold.

Payments made to and from companies

1.107 The first exception to the obligation of a custodian to withhold applies if the custodian is a company [Schedule 1, item 1, paragraph 12-390(10)(a)] . Withholding is not required in respect of a payment made by a corporate custodian unless the custodian is acting in the capacity of a trustee or as an agent for a principal. For this purpose, both a public trading trust and a corporate unit trust is a company [Schedule 1, items 8 and 10, subsections 102L(10) and 102T(11) of the ITAA 1936].

1.108 In order to determine whether a company is acting as an agent of the foreign resident in this context, the special rules in Subdivision 12-H that operate to deem an entity that is an agent of a principal not to be acting as an agent for certain purposes, have no application [Schedule 1, item 1, paragraph 12-390(10)(a)] . As a consequence, a corporate custodian that is an agent of an entity with a relevant connection outside Australia may be required to withhold an amount, under the new rules implemented by this Schedule, from an advance it makes to the entity.

1.109 The exception does not apply to a corporate custodian that is acting in the capacity of trustee. Subsection 960-100(4) of the ITAA 1997 provides that where a provision refers to a particular kind of entity it refers to the entity in that capacity not to the entity in any other capacity. This means a corporate custodian acting in the capacity of trustee may be required to withhold an amount from a payment it makes to a recipient with a relevant connection outside Australia.

Example 1.7

Jones Trust, a managed investment trust, makes three fund payments, one payment each to:

•

White Custodians Ltd - an Australian resident corporate custodian, with one foreign resident shareholder, Ben.

•

Grey Custodians Ltd - an Australian resident corporate custodian acting in the capacity of a trustee, with one foreign resident beneficiary, Jean, who has provided to the company an address outside Australia.

•

Blue Custodians Ltd - an Australian resident corporate custodian that is an agent of a foreign resident, Robert.

All three custodians on-pay the payments received from Jones Trust.

•

White Custodians Ltd will not be required to withhold under these rules from the payment it makes to Ben as it did not make the payment as an agent or in the capacity of trustee. White Custodians Ltd may be required to withhold from the payment under the dividend withholding rules (in Subdivision 12-F).

•

Grey Custodians Ltd will be required to withhold from the payment it makes to Jean under these rules as it is acting in the capacity of trustee.

•

Blue Custodians Ltd will be required to withhold from the payment it makes to Robert under these rules as it is an agent of Robert.

Where no underlying managed investment trust withholding is payable

1.110 The second exception to the obligation of a custodian to withhold arises to the extent there is no underlying liability to managed investment trust withholding tax in respect of the amount covered by a requirement to give a notice (or make details available on a website), or an amount reasonably attributable to that amount. [Schedule 1, item 1, paragraph 12-390(10)(b)]

1.111 This is similar to the exception that applies in respect of a payment from a managed investment trust, which is discussed in paragraphs 1.76 to 1.79.

Withholding obligations of other interposed entities (' non-custodians' )

1.112 The existing non-final withholding rules for managed investment trust distributions impose withholding obligations only on managed investment trusts and custodians. Interposed entities that are not custodians ('non-custodians') were excluded from these rules. Therefore, investments in a managed investment trust through a non-custodian have until now been dealt with by the ordinary provisions of the Income Tax Acts (in particular, Division 6 of Part III of the ITAA 1936, concerning the taxation of trusts).

1.113 The new managed investment trust withholding tax rules in Subdivision 12-H apply to payments received directly (from the managed investment trust) or indirectly (through an interposed entity, being either a custodian or a non-custodian). The extension of the rules to non-custodians is on the basis that this is a final withholding tax and the policy of the new regime is to attract foreign investment into the Australian managed funds industry, whether this be through direct or indirect investment, through flow-through vehicles.

When is a non - custodian required to withhold ?

1.114 Non-custodians will be required to withhold an amount where both of the following conditions are satisfied:

•

the non-custodian receives a payment, all or part of which is covered by a notice or information made available on a website; and

•

a foreign resident is, or becomes entitled to, an amount attributable to the payment received by the non-custodian.

[Schedule 1, item 1, subsection 12-390(4)]

The payment received by a non-custodian must be covered by a notice or information made available on a website

1.115 The first requirement for withholding by a non-custodian is that all or part of the payment received by the non-custodian must be covered by a notice or information made available on a website [Schedule 1, item 1, paragraph 12-390(4)(a)] . This is similar to the requirement for payments from a custodian which is discussed in paragraphs 1.97 to 1.101.

A foreign resident is or becomes entitled to receive an amount

1.116 The second requirement for withholding by a non-custodian is that a foreign resident is or becomes entitled to receive an amount that is reasonably attributable to the payment received by the non-custodian. [Schedule 1, item 1, paragraph 12-390(4)(b)]

1.117 This requirement varies from the requirements for withholding by managed investment trusts or custodians. A non-custodian is required to withhold at the time a foreign resident is, or becomes, entitled to receive an amount rather than at the time a payment is made by the non-custodian to the foreign resident. Requiring withholding at the time the entitlement crystallises ensures the obligation to withhold an amount cannot be avoided or deferred merely by deferring payment to the foreign resident.

1.118 Additionally, the withholding rules for non-custodians focus on the residency status of the party becoming entitled to receive an amount. Withholding is required where a foreign resident has an entitlement to all or part of the amount received by the non-custodian that was covered by a notice or publication on a website. The non-custodian cannot rely on the proxies for residency (address and place of payment) that apply in the case of payments by managed investment trusts and custodians.

1.119 This recognises that the relationship between a non-custodian and the person entitled to an amount from the non-custodian is likely to be closer than the relationship between a recipient of a payment and a managed investment trust or custodian. This closer relationship means the non-custodian is likely to be in a better position to obtain information as to the actual residency status of the person entitled to receive an amount.

1.120 Requiring a non-custodian to withhold at the time a foreign resident becomes entitled to receive an amount aligns with similar rules in Subdivision 12-F, which require withholding at the time a foreign resident becomes entitled to receive an amount.

The time when withholding is required

1.121 When withholding is required will depend on when the foreign resident becomes entitled to receive the amount from the non-custodian. If the foreign resident is entitled to receive the amount (or is entitled to have the non-custodian credit to them or otherwise deal with the amount on their behalf or as they direct) at the time when the non-custodian receives the payment covered by a notice or the publication of information on a website, withholding is required immediately after the time of receipt. [Schedule 1, item 1, paragraph 12-390(8)(a)]

1.122 If the foreign resident becomes entitled after the time when the non-custodian receives the payment, withholding is required immediately after the foreign resident becomes entitled. [Schedule 1, item 1, paragraph 12-390(8)(b)]

The amount on which withholding is required

1.123 Withholding is required on the amount that the foreign resident is entitled to receive from the non-custodian (or have the non-custodian credit or otherwise deal with on the foreign resident's behalf or as the foreign resident directs) that is reasonably attributable to the part of the payment received by the non-custodian that was covered by a notice or the publication of information on a website. [Schedule 1, item 1, subsections 12-390(4) and (5)]

Example 1.8

Seville Trust, a managed investment trust in relation to an income year, makes a payment of $2,000, all of which represents a fund payment for that income year, to Alvin (a non-custodian), who is an agent of Simon, a foreign resident.

Alvin's fees as agent are 5 per cent of the payments received. Alvin must pay all amounts, net of his fee, to Simon within two days of the date payment is received by Alvin.

Seville Trust is not required to withhold from the payment and, therefore, issues a notice to Alvin.

The relationship between Alvin and Simon is two-fold:

•

in his capacity as agent, Alvin is required to pay to Simon the amounts received; and

•

because Alvin is operating as Simon's agent, Simon is required to pay him a fee calculated by reference to the amounts received by Alvin.

On this analysis, Simon is entitled to receive an amount of $2,000, which is attributable to a payment received by Alvin, all of which is reasonably attributable to a fund payment. Withholding will be required, by Alvin, on this amount.

Alvin will pay, to Simon, the amount remaining after deduction of the withholding amount and the administration fee.

What is the rate of withholding ?

1.124 The rate at which a non-custodian must withhold depends upon whether the foreign resident is resident of an 'information exchange country'.

1.125 Australian taxation law defines what is meant by 'Australian resident' and 'foreign resident' (subsection 995-1(1) of the ITAA 1997). It does not prescribe when an entity will be considered a resident of a particular foreign country.

1.126 For this reason, these rules provide that an entity will be considered a resident of an information exchange country where the entity is a resident of that country for the purposes of the taxation laws of that country. [Schedule 1, item 1, paragraph 12-390(7)(a)]

1.127 There will be circumstances where an entity will be unable to apply the above test. For example, the test cannot be applied in the case of those information exchange countries that do not have taxation laws (as is the case with some territories with which Australia has Tax Information Exchange Agreements). Alternatively, there may be a case where a country does have taxation laws, however, those laws do not apply to the entity in question and, accordingly, the test cannot be applied.

1.128 In cases where there are no taxation laws applicable to the entity, the foreign resident will be considered a resident of an 'information exchange country' if:

•

the foreign resident is an individual, and ordinarily resident in that country; or

•

in any other case, the entity was incorporated or formed in that country and is carrying on business in that country.

[Schedule 1, item 1, paragraph 12-390(7)(b)]

1.129 A person will be considered to be ordinarily resident in a country if that is the place where they normally reside.

1.130 An entity that is not an individual will be considered a resident of an information exchange country if the entity was both formed (or incorporated) in that country and is carrying on business in that country. By having the carrying on business test in conjunction with the place of incorporation or formation test, only entities actually undertaking genuine business activities in that country can meet the test.

Payments that are not liable to withholding

1.131 There are two exceptions to the obligation to withhold for non-custodians. Withholding is not required:

•

in respect of a payment received by a corporate non-custodian unless the company is acting in the capacity as an agent or trustee of the foreign resident; or

•

in respect of a payment received by the non-custodian to the extent there is no underlying managed investment withholding tax liability.

[Schedule 1, item 1, subsection 12-390(10)]

1.132 A discussion of the exceptions to the withholding obligations is in paragraphs 1.107 to 1.109 and 1.76 to 1.79.

Obligations of a non-custodian to give a notice or make information available on a website

1.133 A non-custodian will be required to give a notice or make information available on a website where all the following conditions are satisfied:

•

the non-custodian receives a payment;

•

an entity (not being a foreign resident) is or becomes entitled to receive from the non-custodian (or to have the non-custodian credit, or otherwise deal with the payment, on their behalf or as they direct) an amount attributable to the amount received; and

•

had a foreign resident entity been so entitled to receive the amount, an amount would have been required to have been withheld by the non-custodian.

[Schedule 1, item 1, subsections 12-395(4) and (5)]

1.134 The notice must be provided to the foreign resident or the information must be made available on a website by the non-custodian at or before the time the amount is paid, credited or otherwise dealt with. [Schedule 1, item 1, subsection 12-395(6)]

1.135 The details that must be specified in the notice or made available on the website are discussed in paragraphs 1.83 to 1.90.

Implications of failure to withhold

An entity commits an offence and is liable to an administrative penalty

1.136 Where an entity fails to withhold an amount, as required, the entity will commit an offence of strict liability under section 16-25.

1.137 Further, the entity (other than an exempt Australian Government agency) is liable to pay to the Commissioner a penalty equal to the amount that was required to be withheld under section 16-30.

1.138 Subdivision 298-A of Part 4-25 is also relevant as it sets out a number of provisions that apply to administrative penalties, including the accrual of general interest charge on an unpaid penalty and the Commissioner's discretion to remit all or part of a penalty. Subdivision 298-A applies to the penalties that may arise for failure to withhold an amount. [Schedule 1, item 56, paragraph 298-5(c)]

An entity liable to the withholding tax is entitled to a credit where another entity has paid the penalty

1.139 Where an entity has paid a penalty for failure to withhold, the entity liable to the managed investment trust withholding tax is entitled to a credit equal to the amount of the penalty, or general interest charge, as appropriate [Schedule 1, item 46, paragraph 18-35(1)(a)] . This is consistent with the existing crediting rules that apply to dividends, interest and royalties.

1.140 Although the entity liable to the tax will not have borne the incidence of the tax (as that, effectively, has been borne by the entity liable to the penalty), as the Commissioner has received an amount equal to the amount that would have been withheld had the failure to withhold not occurred, it is appropriate the foreign resident's liability to tax be discharged to the extent of the penalty.

An entity liable to an administrative penalty is entitled to recover the penalty

1.141 An entity liable to an administrative penalty for failing to withhold an amount is entitled to recover an amount equal to the amount of the penalty from the person liable to pay the managed investment trust withholding tax on that payment [Schedule 1, items 36 and 37, section 16-195 and paragraph 16-195(1)(c)] . This is consistent with the existing provisions that apply to dividends, interest and royalties (as well as other payments such as the departing Australia superannuation payment and mining payments).

1.142 These provisions recognise that the entity liable to the withholding tax has received a windfall gain as the payment received by it was never reduced by withholding. As the foreign resident's liability is subsequently extinguished, by virtue of the credit that arises where the administrative penalty representing the withholding amount that would have been collected is paid (refer to paragraphs 1.239 to 1.242), the entity liable to the withholding tax is no longer liable to pay that tax to the Commissioner.

1.143 To allow a foreign resident to benefit from an offence committed by another entity would be inappropriate and inconsistent with the approach adopted in relation to other withholding amounts. For this reason, the entity that is liable to the administrative penalty is entitled to recover the amount of the penalty from the foreign resident liable to the withholding tax.

Implications of failure to give a notice or make information available on a website

What is a failure to give a notice or make information available on a website ?

1.144 An entity will have failed to give a notice or make information available on a website in the following circumstances:

•

the entity is required to give a notice or make information available on a website and does not do so;

•

the entity purports to provide a notice or make information available on a website but this is not done at or before the required time;

•

the purported notice or information made available on the website does not, or does not correctly, specify the details as required.

An entity liable to an administrative penalty

1.145 As the requirement to give a notice or make information available on a website is a critical component of the withholding regime implemented by this Schedule, it is appropriate that failure to give a notice or make information available on a website as required will give rise to an administrative penalty.

1.146 The administrative penalty is equal to the amount that would have been withheld from the payment or from amounts reasonably attributable to the payment had the notice or publication requirements been satisfied in respect of each payment and each amount reasonably attributable to the payment. In determining the penalty amount, paragraph 12-390(1)(b) is disregarded because knowledge of the ultimate withholding tax liability may be difficult to obtain. [Schedule 1, item 1, section 12-415]

Example 1.9

Jones Trust, a managed investment trust, makes two payments of $5,000 each to D Custodian and B Trust. Both entities do not have a relevant connection outside Australia. As a result, Jones Trust is required to issue notices or make information available on a website in respect of each payment but does not do so.

D Custodian makes two payments of $2,500; one to Sasha (to a UK bank account) and one to Harry (to an Australian bank account). D Custodian is not required to withhold from the payment to Sasha because D Custodian is not in receipt of a notice from the Jones Trust, nor has information relating to the payment been made available on a website.

B Trust (a non-custodian) has one beneficiary, Martin, a resident of Singapore (a country with which Australia does not have effective exchange of information). Martin is entitled to receive the payment of $5,000 (made by Jones Trust) at the time it is received by B Trust. B Trust is not required to withhold from the amount to which Martin is entitled because B Trust did not receive a notice from Jones Trust, nor was information relating to the payment provided on a website.

Jones Trust is liable to an administrative penalty in respect of each payment of $5,000 that it made. The administrative penalty is equal to the amount that would have been withheld had the payment by Jones Trust and all amounts reasonably attributable to that payment been covered by a notice or publication on a website.

Jones Trust is, therefore, liable to pay the Commissioner a penalty of $1,875. This is calculated as $375 in relation to the payment that is made by D Custodian to Sasha (calculated as 15% × $2,500) and $1,500 in relation to Martin's entitlement to an amount received by B Trust (calculated as 30% × $5,000).

Sasha and Martin are entitled to a credit for the penalty paid by Jones Trust (as against their respective liabilities to managed investment trust withholding tax). Jones Trust is able to recover from both Sasha and Martin (who are liable to pay managed investment trust withholding tax) the amount of each penalty (but limited to the related tax liability of Sasha and Martin) - in this case, $375 and $1,500 respectively.

1.147 Further discussion of the provisions that generally apply to administrative penalties is in paragraphs 1.138 and 1.234 to 1.242.

An entity liable to an administrative penalty is entitled to recover an amount

1.148 By analogy with the rules regarding failure to withhold, the new rules implemented by this Schedule provide that where an entity is liable to pay an administrative penalty for failing to provide a notice or make information available on a website, the entity may be liable to recover an amount equal to the administrative penalty from the entity with an underlying liability to managed investment trust withholding tax. [Schedule 1, item 38 , subsections 16-195(2) and (3)]

1.149 Allowing for this recovery recognises the person with the underlying withholding tax liability has received a windfall gain as, despite the fact that no amount was withheld from the payment received by the person, the person's liability can be offset by the credit that arises where the administrative penalty is paid [Schedule 1, item 47, subsection 18-35(1A)] . For this reason, it is appropriate the entity that is liable to the administrative penalty be entitled to recover the amount of the penalty from the person liable to the tax.

1.150 The amount that may be recovered by the entity that has paid the administrative penalty is capped to the managed investment trust withholding liability of the foreign resident. [Schedule 1, item 38, subsections 16-195(2) and (3)]

Example 1.10

Halliwell Trust, a managed investment trust, makes a fund payment of $1,000 to Prudence Custodians, an Australian resident. Halliwell Trust does not provide a notice or make information available at or before the time of payment and, therefore, Prudence Custodians does not withhold from the fund payment that it on-pays to the Singapore bank account of Piper Trust, a trust that is resident in Singapore (a country that is not an exchange of information country).

Phoebe is a New Zealand resident and a beneficiary of Piper Trust. She receives a payment of $1,000 all of which is attributable to the fund payment of Halliwell Trust. It is assumed that her managed investment trust liability is $150 (15 per cent of $1,000).

Halliwell Trust is liable to an administrative penalty for failure to provide a notice or make information available under section 12-395. The penalty is equal to the amount that would have been withheld from the payment had the notice or publication requirements been satisfied. This means the administrative penalty is equal to $300 (withholding would have been required at the rate of 30 per cent on the $1,000 payment).

Halliwell Trust is entitled to recover the administrative penalty from the person that has the underlying managed investment trust withholding tax liability, being Phoebe, to the extent of the liability, which is $150.

Who is liable to managed investment trust withholding tax ?

1.151 Subdivision 840-M of the new Division 840 of the ITAA 1997, inserted by this Schedule to the Bill, provides the rules for determining if there is a liability to managed investment trust withholding tax.

1.152 Broadly, the liability for managed investment trust withholding tax is imposed on foreign residents in respect of amounts received (or, in some cases, amounts they are entitled to receive) that are represented by or reasonably attributable to fund payments of a managed investment trust.

1.153 The conditions that give rise to a liability for managed investment trust withholding tax differ depending on whether the foreign resident is paid an amount directly from a managed investment trust or a custodian or is entitled to receive an amount from a non-custodian.

1.154 Once a liability to pay managed investment trust withholding tax is established, this liability is formally imposed, and the applicable rate of tax is provided for in:

•

the Income Tax (Managed Investment Trust Transitional) Bill 2008 for the first income year of operation of the amendments made by this Schedule to this Bill for residents of a country with effective exchange of information on tax matters [Schedule 1, item 23, section 840-805 of the IT (TP) Act 1997] . and;

•

the Income Tax (Managed Investment Trust Withholding Tax) Bill 2008 for the first income year of operation of the amendments for residents of other countries and for later income years for all taxpayers [Schedule 1, item 2, subsection 840-805(1) of the ITAA 1997] .

Direct investment in a managed investment trust

1.155 A liability to managed investment trust withholding tax is imposed on a person who receives an amount from a trust that is a managed investment trust in relation to an income year where:

•

all or part of the amount received is a fund payment in relation to that year; and

•

at the time of payment the recipient is foreign resident beneficiary of the managed investment trust and not a beneficiary in the capacity of trustee of another trust.

[Schedule 1, item 2, subsection 840-805(2) of the ITAA 1997]

An entity is paid a fund payment from a managed investment trust

1.156 A liability for the managed investment trust withholding tax is imposed on a beneficiary of a managed investment trust upon payment of an amount from the trust, rather than at the time the beneficiary becomes presently entitled to a share of the trust income of the managed investment trust.

1.157 Payment is used as the relevant benchmark for imposition of the withholding tax liability as such a rule aligns the time at which the underlying liability to withholding tax crystallises with the time when withholding from the payment is required. Withholding is never required from a payment made by a managed investment trust sooner than the time it is paid from the managed investment trust. [Schedule 1, item 1, subsection 12-385(1)]

Constructive payments

1.158 Even where the managed investment trust does not pay an amount, the foreign resident beneficiary will have a withholding tax liability where an amount that is a fund payment is applied or dealt with on the beneficiary's behalf or as the beneficiary directs. [Schedule 1, item 2, paragraph 840-805(2)(a) of the ITAA 1997]

1.159 This rule again ensures alignment between the time at which the liability to withholding tax crystallises and the time when withholding from a payment is required.

1.160 A payer may be obliged to withhold an amount if it has made a constructive payment to the payee. Section 11-5 provides that a constructive payment takes place where an entity applies or deals with an amount in any way on the other's behalf or as the other directs.

Agency rules

1.161 Under normal agency principles, a payment by an entity (the first entity) to an intermediary acting in the capacity of agent for another entity (the principal) would usually be taken to be a payment from the first entity to the principal.

1.162 These amendments displace this rule in one case - where the intermediary is a custodian. In this case, the agency rule is displaced in respect of a payment made to, and from, a custodian such that a payment made by the first entity is taken to be a payment to the custodian in its own right with the payment (or advance) made by the custodian to its principal taken to be a separate payment. [Schedule 1, item 2, section 840-820 of the ITAA 1997]

1.163 The displacement of the agency rule does not affect the nature of the relationship between custodian and recipient, which is that of agent-principal.

Example 1.11

Blue Trust is a managed investment trust. It makes two payments. The first payment is to Green Co. Custodians, an agent of Ben, and the second payment is to Jean, who is an agent of Patrick. Green Co. Custodians and Jean are Australian residents and amounts are paid to addresses in Australia. Both immediately on-pay the amounts to Ben and Patrick, respectively. Both Ben and Patrick are foreign residents.

The agency rule will be displaced in the case of the first payment as Green Co. Custodian is a custodian for the purposes of these amendments. This means the law will recognise two separate payments, being the payment from Blue Trust to Green Co. Custodians and the payment from Green Co. Custodians to Ben. Ben will have a withholding tax liability as he has received payment from Green Co. Custodians that is attributable to a fund payment.

The agency rule will not be displaced in the case of the payment to Jean, as Jean is not a custodian for the purposes of the amendments. The law does not recognise a payment from an agent (Jean) to its principal (Patrick). The payment from Blue Trust to Jean will be treated as a payment from Blue Trust to Patrick. Patrick will, therefore, have a withholding tax liability based on being in receipt of a fund payment from a managed investment trust.

What amount is liable to managed investment trust withholding tax ?

1.164 The withholding tax liability arising out of a payment of an amount from a managed investment trust to a beneficiary of the trust is imposed on that part of the amount that is represented by a fund payment [Schedule 1, item 2, paragraph 840-805(2)(b) of the ITAA 1997] . An explanation of what constitutes a fund payment is set out in paragraphs 1.45 to 1.57.

1.165 If no part of the amount represents a fund payment (eg, it is a distribution of net income attributable to a dividend or interest received by the managed investment trust), it will not give rise to a withholding tax liability under these rules.

1.166 Further, the amount must represent a fund payment in relation to an income year of a managed investment trust for that year [Schedule 1, item 2, paragraphs 840-805(2)(a) and (b) of the ITAA 1997] . The conditions a trust must satisfy in order to qualify as a managed investment trust are set out in paragraphs 1.22 to 1.42.

1.167 If a managed investment trust pays an amount that is a fund payment in relation to a prior income year and the trust was not a managed investment trust for that prior year, no liability to managed investment trust withholding tax will arise in respect of that amount.

Example 1.12

Red Trust, a managed investment trust for the 2009-10 income year, makes a payment that is a fund payment for the 2008-09 income year on 31 August 2009. Red Trust was not a managed investment trust in the 2008-09 income year.

The payment made by Red Trust will not give rise to a managed investment trust withholding tax liability. Rather, the general provisions relating to the taxation of trusts, such as Division 6 of Part III of the ITAA 1936, may apply.

Foreign resident beneficiary is recipient of amount

1.168 The recipient of the fund payment part must be a beneficiary of the managed investment trust for a liability to withholding tax to arise. This ensures if a payment is received by a recipient for any reason other than because they are a beneficiary of the managed investment trust (eg, because the managed investment trust has mistakenly paid an amount to the recipient or has lent an amount to a recipient under a loan agreement), a withholding tax liability will not arise.

1.169 In addition, the recipient will not have a withholding tax liability if it receives the amount from the managed investment trust in a capacity as trustee of another trust [Schedule 1, item 2, paragraph 840-805(2)(c)] . The purpose of this requirement is to ensure that where there are a number of interposed trusts between the managed investment trust and the ultimate recipient of the amount, the liability to managed investment trust withholding tax falls on the ultimate beneficiary rather than any interposed trustee.

1.170 Finally, the recipient must be a foreign resident at the time the recipient is paid the amount from the managed investment trust (or when that amount is applied with or dealt with on the recipient's behalf or as directed by the recipient) for a withholding tax liability to crystallise [Schedule 1, item 2, paragraph 840-805(2)(d)] . If the recipient is a foreign resident at any other time (such as at the time of present entitlement) but not at the time of payment from the managed investment trust, a liability to managed investment trust withholding tax will not arise. Rather, the general provisions relating to the taxation of trusts such as Division 6 of Part III of the ITAA 1936 may apply.

Example 1.13

Brady Trust, a managed investment trust, makes two fund payments of $2,000 one to each of its two beneficiaries, Marcia and Jan. Both payments are made on 1 December 2009. Marcia moves to Australia and becomes an Australian resident on 21 November 2009.

Marcia is not a foreign resident at the time the amount representing the fund payment is paid to her. Therefore, she is not liable to managed investment trust withholding tax. However, if Marcia was presently entitled to a share of the income of Brady Trust, she will be assessed on that share of the net income of the trust under Division 6 of Part III of the ITAA 1936.

Jan is a foreign resident at the time the fund payment is paid to her from Brady Trust. Therefore, Jan will have a liability to managed investment trust withholding tax.

1.171 A beneficiary that is a foreign resident may not be liable to managed investment trust withholding tax where it otherwise might be, if the beneficiary is paid an amount in the course of carrying on a business through a permanent establishment in Australia [Schedule 1, item 2, subsection 840-805(6) of the ITAA 1997] . This exception to the rule is discussed in paragraphs 1.204 to 1.207.

Investing through an interposed entity that is a custodian

1.172 A liability to managed investment trust withholding tax is imposed on a recipient that is paid an amount from a custodian where:

•

all or part of the amount paid by the custodian is reasonably attributable to a fund payment in relation to a year of income of a managed investment trust for that year of income ('the fund payment part');

•

the recipient is foreign resident at the time of payment, is a beneficiary of a trust in respect of the received amount and is not a beneficiary in the capacity of trustee of another trust; and

•

the custodian is either not a company or, if it is a company, is acting in the capacity as agent of the foreign resident.

[Schedule 1, item 2, subsection 840-805(3) of the ITAA 1997]

1.173 Each of these conditions is considered below.

An entity is paid an amount reasonably attributable to a fund payment

1.174 Managed investment trust withholding tax is imposed on amounts that are reasonably attributable to fund payments of a managed investment trust. The trust must have been a managed investment trust for the year of income to which the fund payment relates. [Schedule 1, item 2, paragraph 840-805(3)(b) of the ITAA 1997]

1.175 If the trust did not satisfy the relevant test to be a managed investment trust for the year of income to which the relevant fund payment relates, a liability to managed investment trust withholding tax can never arise in respect of that amount. There may be other provisions of the income tax law that apply in respect of that amount (such as Division 6 of Part III of the ITAA 1936).

1.176 There must be a nexus between the amount received from the managed investment trust by the custodian (which would be the fund payment or, if through another intermediary, an amount attributable to the fund payment) and the on-payment made by the custodian. In most cases, this nexus would be clear as custodians are generally required to on-pay payments received on behalf of a customer within 24 hours of receipt, in some cases, net of administration fees. If a nexus cannot be shown between the payment received by the custodian and the on-payment made by the custodian, the amount on-paid will not attract managed investment trust withholding tax.

1.177 Paragraphs 1.45 to 1.57 provide explanation of what constitutes a fund payment.

1.178 The rules on constructive payments and agency rules that apply in the case of a payment directly from a managed investment trust are also relevant for payments from a custodian. These rules are discussed in paragraphs 1.158 to 1.163.

1.179 The effect of the displacement of the agency rules is that, irrespective of whether the custodian is acting in the capacity of trustee or agent of a foreign resident, the withholding tax liability will arise at the time payment is made by the custodian. This avoids some of the complexities otherwise associated with determining whether the custodian-recipient relationship is one of agent-principal or trustee-beneficiary.

1.180 Payment is used as the relevant benchmark for imposition of the withholding tax liability for the same reasons as it is used in the case of a direct payment from a managed investment trust (see paragraph 1.157).

A foreign resident beneficiary is the recipient of an amount from a custodian

1.181 The requirement that the recipient is a foreign resident at the time of payment, is a beneficiary of a trust in respect of the received amount and is not a beneficiary in the capacity of trustee of another trust, are similar conditions to those required for a direct fund payment from a managed investment trust to attract a withholding obligation [Schedule 1, item 2, paragraphs 840-805(3)(c) and (d) of the ITAA 1997] . Those requirements are discussed in paragraphs 1.168 to 1.170.

1.182 A beneficiary that is a foreign resident may not be liable to managed investment trust withholding tax where it otherwise might be, if the beneficiary is paid an amount in the course of carrying on a business through a permanent establishment in Australia [Schedule 1, item 2, subsection 840-805(6) of the ITAA 1997] . This exception to the rule is discussed in paragraphs 1.204 to 1.207.

The custodian is not a company

1.183 There is a special rule regarding liability to withholding tax that may arise in respect of payments from a custodian. The withholding tax rules will not apply to payments from custodians that are companies, except where the custodian is a company acting as the recipient's agent. [Schedule 1, item 2, paragraph 840-805(3)(e) of the ITAA 1997]

1.184 If the custodian is a company, the payment from the custodian may be a dividend, in which case the payment may be subject to dividend withholding tax, and not managed investment trust withholding tax.

1.185 However, if the company is acting as a foreign resident's agent the payment from the company is not received by the foreign resident in the capacity of a shareholder of the company (and therefore, dividend withholding tax would not be appropriate).

1.186 It is appropriate that a managed investment trust withholding tax liability may arise in respect of a payment from a company acting as agent of the foreign resident. In this case, the payment from the company will be recognised because of the displacement of the agency rule in relation to payments [Schedule 1, item 2, section 840-820 of the ITAA 1997] . The displacement of the agency rules is discussed in paragraphs 1.161 to 1.163.

Other indirect investments through non-custodians

1.187 In relation to investments through non-custodians, a liability to managed investment trust withholding tax will arise where the following requirements are met:

•

the beneficiary of a trust that is a non-custodian (ie, is not a managed investment trust nor a custodian) is presently entitled to a share of the income or capital of the trust and all or part of that share is reasonably attributable to a fund payment in relation to an income year of a managed investment trust for that year [Schedule 1, item 2, paragraphs 840-805(4)(a) and (b) of the ITAA 1997] ; and

•

the beneficiary is not a trustee of another trust in respect of the share of the income or capital of the trust and is a foreign resident at the time of present entitlement [Schedule 1, item 2, paragraphs 840-805(4)(c) and (d) of the ITAA 1997] .

An entity is presently entitled to an amount reasonably attributable to a fund payment

1.188 In relation to this first requirement, it is necessary that:

•

the beneficiary is presently entitled to a share of the income or capital of the trust; and

•

that share is reasonably attributable to a fund payment in relation to an income year of a managed investment trust for that year.

Liability based on present entitlement

1.189 Where the investment is undertaken through a trust that is not a managed investment trust or a custodian, liability to managed investment trust withholding tax is imposed on the basis of present entitlement. This aligns with the approach currently adopted to the imposition of dividend, interest and royalty withholding tax under Division 11A of the ITAA 1936.

Treatment of capital of the trust

1.190 Subsection 95A(2) of the ITAA 1936 applies to deem a beneficiary to be presently entitled in circumstances where the beneficiary has a vested and indefeasible interest in any of the income of a trust but is not actually presently entitled to that income.

1.191 These amendments extend the operation of section 95A, for the purposes of section 840-805, to apply to capital of a trust in the same way as it applies to income. [Schedule 1, item 2, subsection 840-805(5) of the ITAA 1997]

1.192 The extension of subsection 95A(2) in this manner will deem a beneficiary with a vested and indefeasible interest in a share of the capital of a trust to be presently entitled to that share of capital. The concept of present entitlement to capital has previously been recognised in the tax law in the context of Division 6D of Part III of the ITAA 1936.

Example 1.14

An Australian resident trust, Purple Trust, receives a 'fund payment' from a managed investment trust that is made up of a $100 capital gain (not eligible for the CGT discount) from taxable Australian property and $100 rent. Purple Trust does not derive any other income during the income year.

The trust has two beneficiaries with one, Greg, being an income beneficiary and the other, Ben, a capital beneficiary. Both beneficiaries are foreign residents. Greg is presently entitled to the $100 income will have a withholding tax liability on $100.

Ben, who has a vested and indefeasible interest in the capital of the trust, is deemed to be presently entitled to the $100 capital gain. This is because Ben is presently entitled to a share of the capital of the trust and that share is reasonably attributable to the $100 capital gain component of the 'fund payment'. Ben will also have a withholding tax liability on $100.

An amount reasonably attributable to a fund payment

1.193 A withholding tax liability is only ever imposed on a share of income or capital of a trust to which a beneficiary is presently entitled that is reasonably attributable to a fund payment. As a fund payment represents, in effect, a distribution of net income (less certain excluded amounts and related deductions), a beneficiary can only ever be taxed on amounts that form part of the net income of the trust.

1.194 It is necessary that the fund payment be a fund payment of a trust that is a managed investment trust for the year of income to which the fund payment relates. This nexus is necessary because a fund payment is, broadly, calculated with reference to the net income of a trust (less excluded amounts and related deductions) and, therefore, potentially a distribution from any trust could qualify as a fund payment. [Schedule 1, item 2, paragraph 840-805(4)(b) of the ITAA 1997]

A foreign resident beneficiary is presently entitled to the amount

1.195 A beneficiary of a trust (other than a managed investment trust or custodian) that is not a trustee of another trust is liable to managed investment trust withholding tax if the beneficiary is a foreign resident becoming presently entitled to a share of the income or capital of the trust that is attributable to a fund payment. [Schedule 1, item 2, paragraphs 840-805(4)(c) and (d) of the ITAA 1997]

1.196 If the beneficiary is not a foreign resident at the time of becoming presently entitled but is a foreign resident at a later time (such as at the time of payment or year end), a liability to managed investment trust withholding tax will not arise. However, other provisions of the income tax law may apply.

Example 1.15

Moe is a beneficiary of an Australian resident trust. The trust is neither a managed investment trust nor a custodian. The trust's net income includes an amount that is reasonably attributable to a fund payment of a managed investment trust (the Simpson Trust). The fund payment relates to the income year in which the Simpson Trust is a managed investment trust.

Moe is an Australian resident beneficiary at the time he is presently entitled to a share of the income of the Australian resident trust. He then migrates to the US and is a US resident at the time an amount, representing his interest in the trust income, is paid to him. He remains a US resident for the remainder of the income year.

As Moe is not a foreign resident at the time of present entitlement, he will not be subject to managed investment trust withholding tax on his share of the net income of the trust that is reasonably attributable to a fund payment. Rather, the provisions of Division 6 of Part III of the ITAA 1936 will apply (see section 98 of that Act).

1.197 A beneficiary that is a foreign resident may not be liable to managed investment trust withholding tax where it otherwise might be if the beneficiary becomes presently entitled to an amount in the course of carrying on a business through a permanent establishment in Australia [Schedule 1, item 2, subsection 840-805(6) of the ITAA 1997] . This exception to the rule is discussed in paragraphs 1.204 to 1.207.

How does the rule apply to interposed partnerships ?

1.198 Although these rules for liability for managed investment trust withholding tax are couched in terms of a person being a beneficiary in a trust, they could apply where a partnership in Australia receives a payment from a non-custodian trust which is reasonably attributable to an earlier fund payment from a managed investment trust. In this case, it is intended that the liability to managed investment trust withholding tax is imposed on the partner.

1.199 Therefore, just as there may be an obligation for a partnership to withhold an amount from a payment it receives (if it is receiving it for a foreign resident partner that is or becomes entitled to the amount), there will be a similar crystallisation of a liability to managed investment trust withhold tax on the partner.

Example 1.16

Smart Brothers is a partnership that is presently entitled to receive a $100 distribution from NC Trust (a non-custodian) which is reasonably attributable to a fund payment from MI Trust (a managed investment trust). Smart Brothers is paid the amount in Australia and both MI Trust and NC Trust provide information in relation to the payment as required under section 12-395.

Maxwell is a partner of Smart Brothers and is a foreign resident at the time he becomes entitled to receive $40 (as its partnership distribution). Smart Brothers has an obligation (under subsection 12-395(4)) to withhold an amount in respect of the $40 to which Maxwell becomes entitled.

Maxwell would be considered to be a beneficiary of the NC Trust and is presently entitled to a share of the income of the trust that is reasonably attributable to a fund payment. Maxwell is liable to pay managed investment trust withholding tax. (Subsection 840-805(4) of the ITAA 1997.)

Note that if in this example Smart Brothers held a direct investment in MI Trust (and NC Trust did not exist) Maxwell's liability to withholding tax would instead arise under subsection 840-805(2), being an amount that is applied or dealt with by a managed investment trust as directed (under paragraph (a) of that subsection).

What happens where the non - custodian intermediary is an agent ?

1.200 A foreign resident may invest in a managed investment trust through an agent that is not a custodian (ie, a 'non-custodian agent').

Agency rules are not displaced

1.201 The changes that displace the agency rule only apply in the case of payments to and from a custodian (refer to the discussion in paragraphs 1.161 to 1.163). Therefore, a payment from a managed investment trust to a non-custodian agent will be taken to be a direct payment from a managed investment trust to the foreign resident principal.

1.202 The liability rules in subsection 840-805(2) of the ITAA 1997 for liability applying to direct investment in a managed investment trust are applicable. Those rules are discussed in paragraphs 1.151 to 1.171.

1.203 The relevant event giving rise to a liability for managed investment trust withholding tax is the payment from the managed investment trust to the non-custodian agent. Where the managed investment trust applies or deals with an amount on the behalf of the non-custodian agent or as the non-custodian agent directs, it will be take to make a payment to the principal.

An exception if business is carried on through an Australian permanent establishment

1.204 There is a general exception to a liability for managed investment trust withholding tax where an entity is paid a fund payment part (including constructive payment) or becomes entitled to it in the course of a business carried on by the entity at or through an Australian permanent establishment. [Schedule 1, item 2, subsection 840-805(6) of the ITAA 1997]

1.205 This exception is relevant in respect of all situations where there may be a liability to managed investment trust withholding tax - involving the payment of an amount from either a managed investment trust or a custodian, or an entitlement to an amount from a non-custodian.

1.206 This rule is consistent with the existing rules applying to interest and dividend payments paid to an entity in carrying on business in Australia at or through a permanent establishment in Australia (in paragraph 128B(3)(h) and subsection 128(3E) of the ITAA 1936, respectively).

1.207 If a foreign resident is carrying on a business in Australia through a permanent establishment but is paid a fund payment part that is not received in the course of a business carried on at or through an Australian permanent establishment, it will not be covered by this exception.

Amounts on which managed investment trust withholding tax is imposed are non-assessable and non-exempt income

1.208 Income on which managed investment trust withholding tax is payable is made not assessable and not exempt income of an entity [Schedule 1, item 2, section 840-815 of the ITAA 1997] . This is consistent with the purpose of the new managed investment trust withholding tax regime to impose a final rate of withholding tax on distributions subject to managed investment trust withholding tax.

1.209 It is also consistent with the approach adopted in Division 11A of Part III of the ITAA 1936, which (except in some limited cases) makes dividends, interest and royalties that are subject to the withholding tax not assessable and not exempt income of a person (under section 128D of the ITAA 1936).

1.210 Making the income non-assessable and non-exempt income of an entity ensures that:

•

the amounts upon which the tax is imposed are not assessable under any other provision of the income tax law in the hands of any entity; and

•

deductions (in respect of expenses relating to the derivation of that income) cannot be claimed as no relevant amount is included in assessable income (refer to subsection 8-1(2) of the ITAA 1997).

1.211 Noting that although these amounts are non-assessable and non-exempt income, there is a special rule (that applies in certain cases) in relation to the calculation of the liability to managed investment trust withholding tax for the first income year of operation of these amendments. These transitional rules reduce the amount on which the income tax liability is calculated by the relevant losses or outgoings [Schedule 1, item 23, subsections 840-805(1), (3) and (4) of the IT (TP) Act 1997].

1.212 Being not assessable and not exempt, the income will not affect the calculation of an entity's tax loss for a year of income under section 36-10 of the ITAA 1997. Also, if an entity makes a tax loss under section 36-10 of the ITAA 1997, the managed investment trust withholding tax will be payable regardless.

Example 1.17

Wilma Flintstone is a foreign resident who has investments in an Australian rental property and a managed investment trust.

Her assessable income from the Australian rental property is $10,000 for the 2009-10 year of income. She has allowable deductions relating to that income of $12,000. In the same income year she also receives a distribution of $3,000 from the managed investment trust, which consists entirely of a 'fund payment'.

Wilma will be liable to managed investment trust withholding tax on the distribution of $3,000 received from the managed investment trust. This distribution does not affect the calculation of her tax loss. Consequently, Wilma will have a tax loss of $2,000 for the year of income.

1.213 The effect of the changes is that the amount subject to managed investment trust withholding tax is not assessable and not exempt, not only in the hands of the entity liable to the managed investment trust withholding tax, but also in the hands of any other entity (including the trustee of a trust) that would otherwise have been subject to tax in respect of that income.

Example 1.18

On 1 August 2012, the Purple Managed Investment Trust makes a payment of $100 to the Orange Custodian (an Australian resident trust) all of which is identified as a fund payment in relation to the 2011-12 income year. The Orange Trust on-pays $100 to Mr Green at an address in Great Britain and withholds $7.50, which it remits to the Commissioner of Taxation in Australia.

Mr Green has a liability to withholding tax equal to $7.50 against which he can claim as a credit the amount withheld by Orange Custodian. The $100 amount he receives is not assessable and is not exempt income of each entity by reason of section 840-815 of the ITAA 1997.

While the $100 received by Orange Custodian (a trust) forms part of the net income of the trust, section 840-815 has the result that neither the trustee is assessed under section 98 of the ITAA 1936 on the amount, nor is Mr Green assessed under section 98A of the ITAA 1936 on the amount.

What is the rate of managed investment trust withholding tax ?

1.214 Upon establishing a liability to pay managed investment trust withholding tax, this liability is formally imposed, and the applicable rate of tax is provided for in:

•

the Income Tax (Managed Investment Trust Transitional) Bill 2008 for the first income year of operation of these amendments for certain taxpayers [Schedule 1, item 23, section 840-805 of the IT (TP) Act 1997]; and

•

the Income Tax (Managed Investment Trust Withholding Tax) Bill 2008 for both the first income year of operation of these amendments for certain taxpayers and for later income years [Schedule 1, item 2, subsection 840-805(1) of the ITAA 1997] .

1.215 For the transitional year of operation of these amendments and subsequent years, the rate of withholding tax is dependent on the residency of the foreign investor.

1.216 Where the foreign investor is resident in a jurisdiction with which Australia has effective exchange of information for taxation matters, the rates of withholding tax will be as follows:

•

22.5 per cent; for fund payments made in relation to the income year commencing the first 1 July following the date of Royal Assent (the rate is imposed by the Income Tax (Managed Trust Transitional) Bill 2008);

•

15 per cent; for fund payments made in relation to the income year commencing the second 1 July following the date of Royal Assent; and

•

7.5 per cent; for fund payments made in relation to income years commencing the third 1 July following the date of Royal Assent.

1.217 The list of jurisdictions with which Australia has effective exchange of information will be set out in regulations to the TAA 1953.

1.218 Australian taxation law defines what is meant by 'Australian resident' and 'foreign resident' (subsection 995-1(1) of the ITAA 1997). It does not prescribe when an entity will be considered a resident of a particular foreign country.

1.219 For this reason, these rules provide that an entity will be considered a resident of an information exchange country where the entity is a resident of that country for the purposes of the taxation laws of that country.

1.220 There will be circumstances where an entity will be unable to apply the above test. For example, the test cannot be applied in the case of those information exchange countries that do not have taxation laws (as is the case with some territories with which Australia has Tax Information Exchange Agreements). Alternatively, there may be a case where a country does have taxation laws, however, those laws do not determine the residency of the entity in question and, accordingly, the test cannot be applied.

1.221 In cases where the country's taxation laws do not determine the residency of the entity, the foreign resident will be considered a resident of an 'information exchange country' if:

•

the foreign resident is an individual, and ordinarily resident in that country; or

•

in any other case, the entity was incorporated or formed in that country and is carrying on business in that country.

1.222 A person will be considered to be 'ordinarily resident' in a country if that is the place where they normally reside.

1.223 If this second test of residency is relevant and the entity is not an individual, it will be considered a resident of an information exchange country if the entity was both formed (or incorporated) in that country and is carrying on business in that country. By having the carrying on business test in conjunction with the place of incorporation or formation test, only entities actually undertaking genuine business activities in that country can meet the second test.

1.224 In any other case, the withholding tax liability will be imposed at 30 per cent. The rate is imposed by the Income Tax (Managed Investment Trust Withholding Tax) Bill 2008.

When is managed investment trust withholding tax due and payable ?

1.225 Managed investment trust withholding tax is due and payable at the end of 21 days after the end of the month in which the managed investment trust withholding tax liability was imposed [Schedule 1, items 2 and 23, section 840-810 of the ITAA 1997 and section 840-810 of the IT (TP) Act 1997] . This is consistent with the time at which the withholding taxes applying to dividends, interest and royalties, as imposed in Division 11A, are due and payable.

1.226 In the case of payments from a managed investment trust or custodian, this will be 21 days from the end of the month in which the payment from the managed investment trust or custodian to a foreign resident was made. [Schedule 1, items 2 and 23, paragraph-840-810(1)(a) of the ITAA 1997 and of the IT (TP) Act 1997]

1.227 In cases where the liability to managed investment trust withholding tax arose as a consequence of a beneficiary being presently entitled to an amount of trust income or capital, the liability will be due and payable at the end of 21 days at the end of the month in which present entitlement arose. For example, at the time a non-custodian intermediary receives a fund payment from a managed investment trust. [Schedule 1, items 23 and 2, paragraph 840-810(1)(b) of the IT (TP) Act 1997 and of the ITAA 1997]

1.228 The managed investment trust withholding tax liability will generally be satisfied by another entity withholding as required under Schedule 12-H of Schedule 1 to the TAA 1953. Such amount will be available as a credit to the foreign resident to reduce their managed investment trust withholding tax liability. This is discussed further in paragraphs 1.234 to 1.238.

1.229 Where withholding does not take place, or is not sufficient to discharge the foreign resident's withholding tax liability in its entirety, there will be an amount of withholding tax liability that will remain due and payable.

What happens if the withholding tax remains unpaid ?

1.230 Once due and payable, the managed investment trust withholding tax becomes a debt due to the Commonwealth. The Commissioner may give a notice of the amount of withholding tax due and the date on which that tax became due and payable [Schedule 1, items 23 and 2, subsection 840-810(2) of the IT (TP) Act 1997 and subsection 840-810(3) of the ITAA 1997] . This is consistent with the approach adopted in relation to other final withholding taxes in Division 11A of Part III of the ITAA 1936.

1.231 If it remains unpaid, a liability for the general interest charge arises from the date upon which the liability was due to be paid. The general interest charge is calculated on the unpaid withholding tax and any accumulated general interest charge from the date the withholding tax was due to be paid until the last day on which the withholding tax on general interest charge thereon remains unpaid. [Schedule 1, items 23 and 2, subsection 840-810(2) of the IT (TP) Act 1997 and of the ITAA 1997]

1.232 The general interest charge is worked out under Division 1 of Part 11A of the TAA 1953.

1.233 The ascertainment of an amount of managed investment trust withholding tax is not an assessment. [Schedule 1, item 2, subsection 840-810(4) of the ITAA 1997]

How is managed investment trust withholding tax discharged ?

Credit for amounts withheld

1.234 An entity that has a liability to managed investment trust withholding tax is entitled to a credit against their liability where:

•

their ordinary or statutory income includes an amount that is represented by or reasonably attributable to a fund payment; and

•

the entity has borne all or part of an amount withheld from the payment.

[Schedule 1, item 44, section 18-32]

1.235 This crediting provision is based on existing crediting provisions that apply in the case of dividends, interest and royalties. It is capable of applying to both Australian and foreign residents.

1.236 The first requirement for a credit is that the entity's ordinary or statutory income includes an amount that is represented by or reasonably attributable to a fund payment. Although the imposition of managed investment trust withholding tax will result in the amount being non-assessable non-exempt it can still be described as ordinary or statutory income within the meaning of the ITAA 1997.

1.237 The entity must have borne all or part of an amount withheld in respect of the amount represented by or reasonably attributable to a fund payment. An entity will have 'borne' the tax where a withholding amount has been deducted from the payment, such that the entity has borne the economic incidence of that tax.

Example 1.19

Trigg Trust is a managed investment trust. It makes two fund payments to two unit holders: Harry, an Australian resident, and Sam, a resident of Hong Kong. Neither Harry nor Sam is under a legal disability and both are presently entitled to the trust income and capital of Trigg Trust in equal proportions at the time of payment.

Harry was living in the UK when he acquired units in Trigg Trust and has not yet advised Trigg Trust of his Australian address. Trigg's records indicate a UK address for Harry.

The income of the Trigg Trust is $2,000, which equals the net income of the trust.

From the gross fund payment of $1,000 Trigg Trust makes to Harry, $75 is withheld (7.5 per cent of $1,000). As such, Harry receives $925.

Harry, being an Australian resident, does not have a managed investment trust withholding tax liability. As he is not under legal disability and is presently entitled to a half share of trust income of Trigg Trust, Harry is liable to tax on that share of the net income of the trust at year end, pursuant to Division 6 (see section 97 of the ITAA 1997). Harry must, therefore, include $1,000 ($925 + $75) in his assessable income. As Harry's ordinary or statutory income is represented by a fund payment and he has borne all of the tax withheld by Trigg Trust ($75) on that fund payment, he is entitled to claim a credit for $75 against his income tax liability.

Trigg Trust's records indicate that Sam has directed payment to be made in Hong Kong. Trigg Trust, therefore, withholds $300 from the fund payment of $1,000 that it makes to Sam. The net payment received by Sam is $700.

As Hong Kong, is not an 'information exchange country', Sam is liable to managed investment trust withholding tax at the rate of 30 per cent on the $1,000 fund payment from Trigg Trust. This means Sam has a managed investment trust withholding tax liability of $300 (30 per cent of $1,000). His ordinary income includes an amount of $1,000 represented by a fund payment and he has borne all of the tax withheld by Trigg Trust ($300) from that fund payment. Therefore, he is entitled to a credit of $300. The credit fully discharges Sam's liability to managed investment trust withholding tax leaving no amount due and payable.

1.238 If the credit to which an entity is entitled is not sufficient to fully discharge the entity's managed investment trust withholding tax liability, the entity will have a debt to the Commonwealth remaining due and payable and subject to the general interest charge. Further discussion can be found in paragraphs 1.230 to 1.232.

Credits for administrative penalties

1.239 If an entity pays an administrative penalty under these rules for failure to withhold an amount as required, or failure to give a notice or make information available, the foreign resident liable to the managed investment trust withholding tax in respect of the amount upon which the penalty was imposed (or an amount attributable to that amount) will be entitled to a credit for the amount of the penalty paid by the entity including any general interest charge [Schedule 1, items 45 to 51, section 18-35] . This is consistent with the approach adopted in respect of dividends, interest and royalties.

1.240 The amount of the credit cannot exceed the managed investment trust withholding tax liability.

1.241 If all or part of the amount of penalty or general interest charge paid by the entity liable to the administrative penalty is subsequently remitted by the Commissioner, the amount of the credit available to the foreign resident liable to the managed investment trust withholding tax is reduced and the Commissioner must pay the amount of penalty or general interest charge remitted to the entity liable to pay the penalty. [Schedule 1, items 48 to 51, paragraphs 18-35(2)(a) and (c) and (3)(a) and (c)]

1.242 The entity liable to pay the administrative penalty is entitled to recover the amount of the penalty, capped at the withholding tax liability, from the foreign resident liable to that tax. For further discussion, see paragraphs 1.141 to 1.143 and 1.148 to 1.150.

Application and transitional provisions

1.243 The amendments contained within this Schedule apply to fund payments in relation to income years starting on or after the 1 July following the day on which this Bill receives Royal Assent [Schedule 1, item 58] . Transitional provisions apply to residents of information exchange countries for the first income year of operation of these amendments [Schedule 1, item 23, Division 840 of the IT (TP) Act 1997].

1.244 The Income Tax (Managed Investment Trust Transitional) Bill 2008 and Income Tax (Managed Investment Trust Withholding Tax) Bill 2008 commence from the day on which they receive Royal Assent.

Consequential amendments

Interaction with Division 6

Amounts subject to managed investment trust withholding tax or withholding under the new rules are not liable to tax under Division 6

1.245 Under the current non-final withholding rules, an amount subject to withholding is excluded from taxation in the hands of the trustee under Division 6 of Part III of the ITAA 1936. This is achieved through a general rule that provides that sections 98, 99 and 99A of the ITAA 1936 do not apply to the net income of a trust estate of a year of income to the extent it represents:

•

income to which a beneficiary was presently entitled; and

•

was represented by or reasonably attributable to an amount from which an entity was required to withhold an amount under the non-final withholding regime.

1.246 In the absence of this provision, section 98 would have applied to tax a trustee of a trust on the share of the net income of the trust as represented the share of the income of a trust to which a foreign resident beneficiary was presently entitled.

1.247 For the non-final withholding rules (which are being repealed by this Schedule) it was necessary to also exclude the operation of sections 99 and 99A, to avoid taxation to the trustee arising as a consequence of subsection 99(3) of the ITAA 1936.

1.248 Under the new final managed investment trust withholding tax rules being inserted by this Schedule, it is not necessary to retain the general rule to exclude the operation of sections 98, 99 and 99A. This is because the new final withholding tax regime makes amounts subject to managed investment trust withholding tax non-assessable and non-exempt income with the result that Division 6 of the ITAA 1936 will not operate to tax these amounts in the hands of any entity. Further discussion of this can be found in paragraphs 1.208 and 1.213.

1.249 The non-final withholding tax rules also contained a specific rule that excluded the operation of subsection 98(4) of the ITAA 1936 in certain cases. This rule provided that subsection 98(4) did not apply to so much of the net income of a trust as represented income to which a beneficiary was presently entitled and that gave rise to an amount from which an entity was required to withhold an amount under the non-final withholding regime.

1.250 The new rules retain the specific rule. Without this rule, circumstances may arise in which an amount that flows to a managed investment trust and forms part of a fund payment subsequently made by the trust, could have been subject to taxation under subsection 98(4) of the ITAA 1936 prior to reaching the managed investment trust. [ Schedule 1, item 6, section 99G of the ITAA 1936 ]

Payments made too late to be fund payments

1.251 Consistent with the existing non-final withholding arrangements, in order to qualify as a fund payment and, therefore, be eligible for withholding, it is necessary for the payment to be made (including constructively made) by the managed investment trust within three months of the end of the income year or within such later period as allowed by the Commissioner. Further discussion on the requirement to pay out the net income of the trust (net of excluded amounts and related deductions) is in paragraphs 1.58 to 1.62.

1.252 Consistent with the change made to the definition of 'fund payment', these rules provide that a capital loss from a CGT event that happens in relation to a CGT asset that is not taxable Australian property is an excluded amount. [Schedule 1, item 7, paragraph 99H(3)(e) of the ITAA 1936]

1.253 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 99 or 99A of the ITAA 1936. The purpose of this approach is to deter trustees from accumulating income within the managed investment trust.

What happens if a beneficiary is an Australian resident for part of a year ?

1.254 Division 6 of the ITAA 1936 may still apply to tax certain amounts where, for part of the year, the beneficiary was an Australian resident. In these cases there is no liability to managed investment trust withholding tax in respect of those fund payments paid to an investor while an Australian resident.

Example 1.20

Abbey is an investor in the MI Trust (a managed investment trust). MI Trust makes a fund payment of $50 on 1 September 2009, at which time Abbey is an Australian resident. MI Trust is not required to withhold from this amount.

On 1 April 2010 MI Trust makes a final fund payment of $200. At the time of payment Abbey is a resident of the UK. MI Trust withholds an amount of $30 (15 per cent of $200) from the payment. At year end, Abbey would be considered to be presently entitled to $250 of the net income of the trust for the purposes of Division 6 of the ITAA 1936. The $200 is a non-assessable amount because managed investment trust withholding tax is payable. However, the $50 paid to Abbey while she was an Australian resident is an amount that the trustee would be assessed on under subsection 98(2A) of the ITAA 1936.

General

1.255 Many consequential amendments result from inserting new Subdivision 840-M into new Division 840 of the ITAA 1997 and the IT (TP) Act 1997. [Schedule 1, items 2, 3, 12, 14, 15, 22, 24, 55 and 57, section 840-1 of the ITAA 1997, section 840-800 of the ITAA 1997, subsection 5(2A) of the Income Tax Act 1986, section 11-55, subparagraph 118-12(2)(a)(vii), paragraph 118-12(2)(a) and subsection 995-1(1) of the ITAA 1997, subsection 8AAB(5), items 39A and 39B in the table in subsection 250-10(2), item 6 in the table in subsection 340-10(2)]

1.256 Other consequential amendments have resulted from repealing the existing Subdivision 12-H and reinserting a new Subdivision 12-H [Schedule 1, items 4 to 6, 13, 17, 19, 25 to 37, 39 to 43, 52 to 54 and 56, section 99G of the ITAA 1936, subsection 995-1(1) of the ITAA 1997, note to subsection 10-5(1), item 26 in the table in subsection 10-5(1), subparagraph 12-315(1)(c)(vii), subsection 15-10(3), note to subsection 15-15(1), subsection 15-35(1), note 2 to section 16-5, note to subsection 16-153(4), note to subsection 16-157(1), heading to Subdivision 16-D, section 16-195, paragraph 16-195(b), section 18-1, subsection 18-10(1), heading to section 18-30, paragraphs 20-35(2)(a) and (b), subsection 45-120(3), paragraph 298-5(c)]

1.257 Definitions have also been inserted into the Dictionary for 'custodian' 'information exchange country', and 'managed investment withholding tax'. [Schedule 1, items 16, 18, 20 and 21, subsection 995-1(1) of the ITAA 1997]

Other obligations

Remittance of amounts withheld

1.258 An entity is required to remit amounts withheld under these rules to the Commissioner in accordance with the existing remittance rules set out in Subdivision 16-B.

1.259 The time when amounts must be paid to the Commissioner will vary depending on whether the withholder is a large, medium or small withholder.

1.260 Section 16-80, which applies to these rules, provides that if an entity fails to pay an amount withheld by the time required, it will be liable to pay the general interest charge. The general interest charge will apply on the unpaid amount for the period starting on the day by which the amount was due to be paid and ending on the last day when the unpaid amount (including accumulated general interest charge) is unpaid.

Requirement to issue a payment summary

1.261 Where an entity is required to withhold an amount under these rules, the entity is also required, at year end, to issue an annual payment summary to the recipient of the payment from which withholding was required.

1.262 The rules provide that a payment summary:

•

must cover each of the payments from which withholding was required;

•

may be in electronic form; and

•

must be given not later than 14 days after the end of the income year of the managed investment trust to which the relevant withholding payments relate, or within a longer period allowed by the Commissioner.

1.263 Withholders are allowed additional time within which to issue a payment summary (the standard time is 14 days after the end of the financial year, pursuant to subsection 16-155(1)) in recognition of the fact managed investment trusts have a period of three months, and up to six months, after the end of the income year during which a payment of net income (less excluded amounts and related deductions) may qualify as a fund payment. For further discussion of the time period within which fund payments must be made, see paragraphs 1.58 to 1.62.

1.264 As with the current non-final withholding rules, the new final withholding rules require the payment summary to set out:

•

the names of the payer and recipient;

•

the tax file number and the Australian Business Number of the recipient, if provided to the payer by the recipient;

•

the total of the payments from which withholding took place and the total of the amounts withheld; and

•

the income year of the managed investment trust to which those withholding payments relate.

REGULATION IMPACT STATEMENT

Background

1.265 Australia is considered to be one of the major markets for funds management, with the industry managing assets worth more than $1.4 trillion. The industry is expected to continue its strong growth, with assets under management anticipated to exceed $2.5 trillion by 2015. This growth has been largely driven by the superannuation sector.

1.266 A feature of the industry is its increasing globalisation, with 20 per cent of assets held by Australian managed funds now being overseas assets. This trend is likely to continue where the supply of appropriate domestic investment assets is unable to meet demand. Foreign investment represents approximately 5 per cent of funds under management.

1.267 The property trust sector forms a key part of the industry, and comprises around 40 per cent of Australian unit trusts. Australian listed property trusts (where the units are listed on the Australian Securities Exchange) currently represent 12 per cent of the world's listed real estate assets, despite Australia geographically comprising only 2 per cent of global real estate. Assets in property trusts are growing strongly, with over 40 per cent of these assets comprising overseas property. This sector is more internationalised than the industry generally. Foreign investment in Australian property trusts amounts to approximately 28 per cent of total investment in those trusts. Much of this is managed by Australian custodians.

1.268 Foreign resident investors are only liable to Australian tax on Australian source income. Foreign source income of foreign residents (eg, income from overseas properties held by Australian trusts), is exempt from Australian tax.

1.269 Australian source dividend, interest and royalty income is subject to final withholding tax at the rates of 30 per cent, 10 per cent and 30 per cent respectively (although these rates may be lower under Australia's tax treaties). Non-final withholding at the rate of 30 per cent applies to distributions of other Australian source income (predominantly income related to property; ie, rental income and capital gains) to a foreign resident.

Problem

1.270 Industry has expressed concern at the low level of foreign investment in the industry generally (although foreign investment in the property trust sector is higher than that in the industry generally). Arguably, the industry is well placed to attract a higher level of foreign investment given the existence of a well developed regulatory regime, strong reputation for funds management and a relatively stable, well performing economic environment.

1.271 While industry itself has noted an inward looking focus, largely due to its domestic success, there is merit in pursuing policy options that could further increase the level of foreign investment in Australian managed investment trusts.

1.272 Industry has identified tax (a high withholding tax rate on distributions from property) and non-tax (regulator responsiveness and limited advocacy/promotional efforts) factors that it believes impede the ability of Australian managed investment trusts to compete for foreign investment.

1.273 In particular, industry contends the existing non-final withholding rate (currently 30 per cent) that primarily applies to distributions of Australian rental income and capital gains from real property is high relative to that applied in its competitor countries and that this headline tax rate is influential in foreign investment location decisions, irrespective of the actual amount of tax foreign residents ultimately pay in their home countries.

Objectives of Government action

1.274 This proposal aims to increase Australia's funds management export earnings by increasing Australia's attractiveness as an investment destination. This is to be achieved by removing a key impediment to the industry's long-term ability to compete globally, that is, the relatively high level of withholding tax.

1.275 The proposal is a part of the Government's election commitment to secure Australia's place as a financial hub in the Asia-Pacific region. The Government's election commitment contemplated replacing the current non-final withholding tax rate of 30 per cent with a final withholding tax of 15 per cent.

Options that may achieve objectives(s )

1.276 The stated objective may be achieved in a number of ways:

•

Option 1 : Reduction of the headline withholding tax rate through Australia's tax treaties.

•

Option 2 : Reduction of the headline withholding tax rate in domestic legislation for all foreign residents.

•

Option 3 : Reduction of the headline withholding tax rate in domestic legislation for residents of foreign jurisdictions with which Australia has effective exchange of information for tax matters.

•

Option 4 : No change to the withholding tax rate, other non-taxation initiatives to be pursued.

Impact analysis

Impact group identification

1.277 The main groups to be impacted by this proposal are:

•

Australian managed investment trusts (predominantly Australian property trusts holding Australian real property);

•

intermediaries (custodians and non-custodians) operating in the industry (Australian service providers that assist with the administration of investment portfolios or agents for foreign resident investors);

•

foreign investors (individuals, companies, superannuation funds and other trusts);

•

Australian investors; and

•

the Australian Government.

1.278 Industry has consistently argued the interim 30 per cent withholding tax rate is the key factor discouraging foreign investment, on the basis it is significantly higher than rates imposed on similar investments by other countries. As a non-final tax, foreign investors are required to lodge an Australian tax return to receive a credit for the tax withheld and/or to claim a tax deduction for any expenses relating to the income. This results in compliance costs for the investor and acts as a disincentive to investment in Australia.

1.279 Industry has proposed the new withholding tax rate be set at 15 per cent, which is, broadly, the average rate applied by other comparable countries. Although setting the withholding tax rate at a higher rate (such as 20 per cent) would mitigate some of the revenue costs associated with this proposal, it may still be uncompetitive and could, therefore, fail to encourage foreign investment. The proposal has, therefore, been examined on the basis of a transition to a final withholding tax rate of 7.5 per cent, which is more comparable within the Asia-Pacific region.

1.280 As a final tax, eligible foreign investors would be relieved of the compliance burden of filing Australian tax returns in respect of this income. However, for some foreign investors this benefit would be offset by the denial of Australian deductions for expenses associated with their investment, which could result in a higher overall tax liability than under the current system.

Option 1 : Implementing the new final withholding tax through new or revised bilateral tax treaties

Background

1.281 This approach would be consistent with the June 2007 recommendation of the Senate Standing Committee on Economics, which advocated reducing the withholding tax payable on distributions from Australian managed investment trusts to foreign residents through Australia's tax treaties where reciprocal benefits were offered to Australian investors.

Benefits

1.282 On the basis that foreign resident investors' decisions are motivated by the headline withholding tax rate (as is industry's contention), Option 1 would enable Australia to target residents of those countries most likely to be the source of additional foreign investment, which would maximise the benefits of a reduced withholding rate.

1.283 Implementation of a reduced withholding tax on a treaty-by-treaty basis would allow Australia to confine the benefits of the reduced withholding tax rate to residents of countries that are prepared to offer reciprocal benefits to Australian investors. This could mitigate the cost to revenue associated with reducing the withholding tax rate. It could also facilitate other policy initiatives that seek to combat the use of tax havens and other harmful tax practices.

1.284 The Australian Government would potentially gain revenue from enhanced activity of Australian based fund managers and custodians. The Australian Taxation Office (ATO) would potentially incur lower administration costs as foreign residents would not be filing Australian tax returns (although to date there is little evidence this occurred).

1.285 Sustained foreign investment may maintain unit values for Australian resident investors (although, given the Australian market is nearly fully securitised, any additional foreign demand, together with continuing domestic demand, could create broader inflationary pressure on underlying property values).

Costs

1.286 Option 1 would take several years to implement, due to the protracted nature of the tax treaty negotiation process. The reduced withholding tax rate would only take effect upon the conclusion of each new or revised tax treaty, with investors from different countries becoming eligible for the reduced rate at different times. This could stagger the benefits that industry anticipates would flow from a reduction in the withholding tax rate.

1.287 Compliance costs for Australian managed funds and custodians would be adversely affected because this approach would require them to ascertain whether each foreign investor was eligible for the final withholding tax rate. Australian managed funds and custodians would also be required to update their withholding systems following the conclusion of each tax treaty, which would entail additional ongoing compliance costs, although it should be noted this would occur anyway in respect of payments of dividends, interest and royalties.

1.288 Foreign investors would become eligible for the reduced withholding tax rates at different times, which may induce certain investors to undertake undesirable practices such as 'treaty shopping' to access the concessional rate. Additional administrative measures may be required to address this.

1.289 The revenue costs associated with Option 1 have not been quantified as the impact of tax treaties are only determined when they are signed, not when negotiations are commenced. It is expected that, over time, the costs associated with Option 1 would approach the costs associated with implementing Option 2 or 3 (where the rate negotiated under the treaties is 7.5 per cent and subject to treaty policy on effective exchange of information).

Option 2 : Unilaterally implementing the new 7.5 per cent final withholding tax through domestic law

1.290 Option 2 would see the final withholding tax being implemented unilaterally through domestic law, rather than through the negotiation of Australia's tax treaties. This is industry's preferred option. A number of the costs and benefits identified in relation to Option 1 apply in this case.

Benefits

1.291 This option would result in all foreign investors being subject to a 7.5 per cent final withholding tax on their fund payments from managed investment trusts. This will be one of the lowest withholding tax rates globally. It will significantly enhance the competitiveness of the Australian funds management industry, and increase their ability to attract foreign investment into the future.

1.292 Implementing the final withholding tax unilaterally through domestic law would be more timely than Option 1 as it would allow the new withholding tax rate to take effect for all foreign investors without the need to wait for individual tax treaties to be negotiated.

1.293 Foreign investors, irrespective of their country of residence, would be eligible for the final withholding tax at the same time.

1.294 This approach would entail lower compliance costs for Australian managed investment trusts and custodians as, unlike Option 1, they would not be required to ascertain whether the particular foreign investor was entitled to the reduced withholding tax rate. This approach also avoids the ongoing system changes that would be associated with Option 1.

1.295 In addition, this approach would lessen the administrative costs for the ATO as ongoing system changes would not be necessitated by this approach.

Costs

1.296 Australia's ability to seek reciprocal benefits for Australian investors in future tax treaty negotiations would be impaired by this option. As the option would benefit residents of all countries equally there would be no incentive for other countries to concede reciprocal rights to Australian residents in treaty negotiations.

1.297 Given the Australian market is nearly fully securitised, any additional foreign investment into the industry, together with continuing domestic demand, could create inflationary pressure on underlying property values.

1.298 Where the reduced withholding tax is made available to all foreign investors, the cost to revenue would be higher than that identified in relation to Option 3 (see paragraph 1.305). Foreign investors excluded from the reduced rates under Option 3 comprise around 20 per cent of current investors.

Option 3 : Implementation of a new final withholding tax regime in the domestic law, with reduced rates limited to residents of foreign jurisdictions with which Australia has effective exchange of information for tax matters .

1.299 Once fully implemented, this option would result in foreign investors resident in exchange of information jurisdictions being subject to a 7.5 per cent final withholding tax on their fund payments from managed investment trusts. As noted above, this will be one of the lowest withholding tax rates globally.

1.300 Where a foreign investor is not a resident of a country with which Australia has effective exchange of information, a 30 per cent final withholding tax will apply to fund payments. This rate is the same as the current interim withholding rate, however, as a final withholding tax, deductions will not be able to be claimed.

Benefits

1.301 This option has many of the benefits identified in relation to Option 2, noting that most foreign investors will be liable to the reduced rates.

1.302 Restricting the reduced withholding tax rate to residents of countries with which Australia has effective exchange of information will enhance the integrity of the new arrangements by providing greater scope to verify the residence of foreign investors and ensure Australian residents are not establishing structures in a foreign country to benefit from the withholding tax rate. Countries that do not have effective exchange of information often deliberately engage in such practices and, thereby, encourage offshore tax evasion.

1.303 It also provides a clear statement of Australia's non-tolerance of international tax evasion and avoidance. Extending the reduced withholding tax rate to jurisdictions that have signed Tax Information Exchange Agreements with Australia will send a strong signal of support to those jurisdictions. This measure is expected to create incentives for other countries to enter into (enhanced) exchange of information arrangements with Australia.

Costs

1.304 This measure is estimated to involve medium costs on managed investment trusts, custodians and non-custodians. The costs are predominantly related to one-off implementation costs, with minimal on-going costs. Costs are expected to be incurred in relation to:

•

modifying existing systems to implement the new withholding regime; and

•

determining the rate of withholding based on the place of payment, address or residency of the foreign investor.

1.305 The above costs are mitigated somewhat by the fact most entities will already have withholding obligations under the existing dividend, interest and royalty regimes, which are very similar to the withholding regime introduced by this measure. The existing dividend, interest and royalty regimes also currently determine the rate of withholding required based on the address, place of payment or residency of the foreign investor.

1.306 There will be a medium administrative impact on the ATO, largely attributable to systems changes to implement the new withholding regime, as well as additional marketing communications and interpretative advice (to ensure that taxpayers have sufficient information regarding the operation of the new withholding regime).

1.307 This measure is expected to have the following revenue implications:

1.308 The cost to revenue is mitigated by the intended phase-down of the withholding tax rate over a three-year implementation period.

Option 4 : No change to the withholding tax rate, other non-taxation initiatives to be pursued

1.309 Industry has indicated that greater regulator responsiveness (where regulators would be required to take account of the implications of their actions for the industry's international competitiveness); increased industry promotion efforts (with increased joint efforts by industry and Government in promoting Australia's funds management experience in the region); and, more focused international trade engagement (where financial services are accorded a greater priority in the negotiation of trade agreements) would enhance the export ability of the funds management industry.

Benefits

1.310 The above initiatives are already being pursued, to various degrees. For example, the Government already promotes the Australian funds management industry through Invest Australia, (although, traditionally, Invest Australia has been primarily focused on encouraging foreign firms to establish operations in Australia rather than assisting Australian firms to export financial services). The recommendations of the Government's Task Force on Reducing the Regulatory Burden on Business (Banks Report) are currently being implemented, and have been received positively by industry.

1.311 As a result, the Government is well placed to enhance and tailor existing efforts so they are better targeted to improving the export of funds management services.

1.312 Industry is also familiar with a number of the bodies that would advance these initiatives, and could be engaged as part of this process.

Costs

1.313 Industry has indicated that although there are a number of non-tax impediments that impact on the export ability of Australia's funds management industry, it is the withholding tax rate that is the most significant disincentive to foreign investment.

1.314 Although addressing the non-taxation impediments would be welcomed by industry, such initiatives, where unaccompanied by a reduction in the withholding tax rate, would not be expected to have as significant an impact on the overall export levels in the industry.

Consultation

1.315 Industry has been strongly supportive of the introduction of a final withholding tax rate of 15 per cent, and has proposed this on a number of occasions. Implementation of a final withholding tax was also explored in hearings before the Senate Standing Committee on Economics when it considered the impacts arising from implementation of the non-final withholding tax system.

1.316 Consultation on the draft legislation commenced following announcement of the measure in the 2008-09 Budget. As the Government intends the measure to take effect from the 2008-09 income year, it was only possible to undertake consultation for a limited period.

1.317 Submissions were received from industry stakeholders (the Investment and Financial Services Association, the Property Council of Australia and the Australian Custodial Services Association), as well as accounting groups (the Institute of Chartered Accountants and Tax Institute of Australia).

1.318 The consultation group were generally strongly supportive of the measure. Suggestions made by representatives on the legislative design of the measure were adopted where consistent with the policy objectives and integrity of the measure.

Conclusion and recommended option

1.319 The option to implement a new final withholding tax, with the reduced rate of withholding of 7.5 per cent available only to residents of effective exchange of information jurisdictions (Option 3) should be pursued.

1.320 This measure will provide a significant boost to the competitiveness of the Australian managed funds industry, especially in the Asia-Pacific region, and is expected to enhance its ability to attract future foreign investment. Relative to Option 2, restricting the reduced withholding tax rate to residents of exchange of information jurisdictions will also enhance the integrity of the tax system and reflects Australia's non-tolerance of international tax evasion and avoidance.

1.321 The approach would be the most effective in achieving the Government's objective in a timely manner. The reduction in the withholding rates has the strong support of industry.

1.322 Implementation of the final withholding tax rate through tax treaties (Option 1) should not be pursued because of the indefinite nature of its implementation, and the fact it would necessitate ongoing administration and compliance costs with the negotiation of each treaty.

1.323 Although there are a range of non-taxation initiatives that may be worthy of consideration (Option 4), it is suggested the potential benefits flowing from such initiatives, absent a reduction in the withholding tax rate, would be more limited. Industry has indicated priority should be given to reducing the tax impediments to increased foreign investment.

Implementation and review

1.324 Option 3 will be implemented in a phased manner. For residents of effective exchange of information jurisdictions, in relation to fund payments arising in the first income year after Royal Assent, a non-final rate of withholding of 22.5 per cent will apply; for the second year, a 15 per cent final withholding tax rate; and, for the third and later years, a 7.5 per cent final rate.

1.325 As a transitional measure, for the first income year, the fund payments will be reduced by certain expenses (such as interest expenses) relating to those fund payments, with the net amount subject to withholding tax of 22.5 per cent. These arrangements are designed to assist such investors in the transition to the final withholding tax regime, by allowing them to utilise deductions incurred in that income year.

1.326 Foreign investors not resident in a jurisdiction with which Australia has effective exchange of information will face a 30 per cent final withholding tax from the first income year following Royal Assent.

1.327 The existing non-final withholding tax regime will be repealed.

1.328 Treasury and the ATO would monitor the new withholding tax regime, as part of the whole taxation system, on an ongoing basis.

1.329 The list of jurisdictions with which Australia has effective exchange of information arrangements, to be prescribed by regulation, will be a matter for ongoing review.

1.330 This measure implements the Government's decision announced in the Treasurer's Press Release No. 043 of 13 May 2008.