House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Treasurer, the Hon Wayne Swan MP

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Government co-contribution for low income earners

Schedule 1 to this Bill freezes indexation of the co-contribution income thresholds for the 2010-11 and 2011-12 income years.

Schedule 1 also permanently maintains the current matching rate and maximum co-contribution that is payable on an individual's eligible superannuation contributions.

Date of effect: 1 July 2010.

Proposal announced: This measure was announced in the 2010-11 Budget on 11 May 2010.

Financial impact: These amendments are expected to result in a $645 million fiscal saving over the forward estimates period.

Compliance cost impact: Low.

Thin capitalisation - modification of the rules in relation to the application of accounting standards for authorised deposit-taking institutions

Schedule 2 to this Bill amends the operation of the thin capitalisation rules for authorised deposit-taking institutions (ADIs) to take account of the change in the accounting treatment of certain assets from the adoption of the Australian equivalents to International Financial Reporting Standards in January 2005.

The relevant assets are:

•

treasury shares;

•

one component of the business asset excess market value over net assets - the EMVONA asset. The relevant component is the value of business in force at the time of acquisition of the relevant subsidiaries; and

•

capitalised software costs.

Certain treasury shares are to be included in adjusted average equity capital.

The safe harbour capital amount is adjusted to exclude the value of business in force component of the business asset excess market value over net assets - the EMVONA asset. This amount is only excluded to the extent to which it is reflected in the goodwill or intangible assets of the ADI group.

The safe harbour capital amount is further adjusted to include only 4 per cent of the value of capitalised software costs.

Date of effect: These amendments will apply to income years commencing on or after 1 January 2009. These amendments do not adversely affect taxpayers.

Proposal announced: This measure was announced in the then Assistant Treasurer and Minister for Competition Policy and Consumer Affairs' Media Release No. 048 of 2009.

Financial impact: Unquantifiable revenue implications from the 2009-10 income year.

Compliance cost impact: Low.

Transactions involving security and intelligence agencies

Schedule 3 to this Bill amends the tax law to provide the heads of the Australian Security Intelligence Organisation and the Australian Secret Intelligence Service with the power to declare that Commonwealth tax laws do not apply to a particular entity in relation to a particular transaction. This ensures that the tax authorities will not need to obtain information that should remain secret in the interests of national security.

Date of effect: Royal Assent.

Proposal announced: This measure has not previously been announced.

Financial impact: An unquantifiable but low revenue impact.

Compliance cost impact: Low.

Special Disability Trusts - changes to the taxation of unexpended income

Schedule 4 to this Bill amends Division 6 of the Income Tax Assessment Act 1936 so that the unexpended income of a Special Disability Trust is taxed at the relevant principal beneficiary's personal income tax rate rather than automatically at the top personal tax rate plus the Medicare levy.

Date of effect: These amendments apply from 1 July 2008 and are beneficial to taxpayers.

Proposal announced: This measure was announced jointly by the Minister for Families, Housing, Community Services and Indigenous Affairs and the Parliamentary Secretary for Disabilities and Children's Services in Media Release Extra support for people with disability and their carers of 12 May 2009.

Financial impact: This measure will have these revenue implications:

Compliance cost impact: Low. This measure will affect only a small proportion of individuals and businesses. There is a low ongoing compliance cost impact and a low transitional impact, reflecting the need for some taxpayers to be aware of the amendments.

Definition of a managed investment trust

Schedule 5 to this Bill amends the definition of a 'managed investment trust' (MIT) in Subdivision 12-H of Schedule 1 to the Taxation Administration Act 1953. The amended definition will apply for the purposes of the MIT withholding tax rules in that Subdivision, and for the purposes of the deemed capital account rules for MITs in Division 275 of the Income Tax Assessment Act 1997 (ITAA 1997).

These amendments to the definition of a MIT also apply in relation to capital gains tax (CGT) events happening on or after 1 November 2008, for the purpose of Subdivision 126-G of the ITAA 1997.

Date of effect: The amendments will apply to fund payments in respect of the first income year starting on or after the first 1 July after the day on which this Bill receives Royal Assent and later income years.

However, if before the day of introduction of this Bill to Parliament, the trustee of a trust makes a fund payment in relation to an income year, the amendments made by this Schedule will not apply to that trust for the 2010-11 to 2014-15 income years.

The amendments will apply in relation to Division 275 of the ITAA 1997 in the same way as the amendments made by Schedule 3 to the Tax Laws Amendment (2010 Measures No. 1) Bill 2010 apply in relation to that Division.

The amendments will apply in relation to CGT events happening on or after 1 November 2008 for the purpose of Subdivision 126-G of the ITAA 1997.

Proposal announced: This measure was announced in the Assistant Treasurer's Media Release No. 020 of 2010.

Financial impact: Unquantifiable revenue implications from the 2010-11 income year.

Compliance cost impact: Low.

Chapter 1 - Government co-contribution for low income earners

Outline of chapter

1.1 Schedule 1 to this Bill amends the Superannuation (Government Co-contribution for Low Income Earners) Act 2003 (Co-contribution Act 2003) to freeze indexation of the co-contribution income thresholds for the 2010-11 and 2011-12 income years.

1.2 Schedule 1 also amends the Co-contribution Act 2003 to permanently maintain the current matching rate and maximum co-contribution payable for eligible personal superannuation contributions.

Context of amendments

1.3 The co-contribution matches eligible personal superannuation contributions made by low to middle income earners. The maximum co-contribution may be payable to persons with incomes up to the lower income threshold. The maximum amount phases down above this level, until it is phased out completely at the higher income threshold.

1.4 The income thresholds are indexed annually to average weekly ordinary time earnings. The lower and higher income thresholds for the 2009-10 income year are $31,920 and $61,920 respectively.

1.5 In the 2009-10 Budget the Government announced a temporary reduction in the matching rate and maximum Government co-contribution payable for eligible personal superannuation contributions. The matching rate and maximum co-contribution are currently legislated to revert back to the levels of the 2008-09 income year in the 2014-15 income year and for later income years.

1.6 In the 2010-11 Budget the Government announced that it would freeze indexation of the co-contribution lower and higher income thresholds for the 2010-11 and 2011-12 income years.

1.7 In the 2010-11 Budget the Government also announced that it would permanently maintain the current matching rate of 100 per cent and maximum co-contribution payable of $1,000.

Summary of new law

1.8 The Government will freeze indexation of the superannuation co-contribution income thresholds for the 2010-11 and 2011-12 income years.

1.9 The Government will permanently maintain the superannuation co-contribution matching rate at 100 per cent and the maximum co-contribution payable at $1,000.

Comparison of key features of new law and current law

Detailed explanation of new law

1.10 The co-contribution is payable for eligible individuals who make personal contributions into superannuation for which a tax deduction has not been claimed. The maximum co-contribution is payable for individuals whose income is at or below the lower income threshold. The co-contribution phases out for individuals whose income is up to the higher income threshold.

1.11 The lower income threshold is indexed annually to full time adult average weekly ordinary time earnings and the higher income threshold is increased by the indexation increase in the lower income threshold for that year. Indexation for an income year is calculated by multiplying the lower income threshold for the previous year by the indexation factor for that later income year.

1.12 Section 10A of the Co-contribution Act 2003 sets out arrangements for increases in the lower and higher income threshold.

1.13 Section 10A will be amended to freeze indexation arrangements for the 2010-11 and 2011-12 income years. These amendments will operate by setting the indexation factor for the 2010-11 and 2011-12 income years at one, which will lead to the income thresholds not changing for these years.

1.14 Subsection 9(1) of the Co-contribution Act 2003 sets out the basic rule for the matching of eligible personal superannuation contributions by the Government co-contribution.

1.15 Section 10 of the Co-contribution Act 2003 sets out the maximum amount of the Government co-contribution payable for an individual for an income year, and the rate at which this amount reduces where an individual's income is above the lower income threshold.

1.16 Subsection 9(1) and section 10 will be amended to provide for the permanent retention of a matching rate of 100 per cent and a maximum co-contribution payable of $1,000.

1.17 For the 2004-05, 2005-06, 2006-07, 2007-08 and 2008-09 income years, the Government co-contribution will continue to be equal to 150 per cent of the eligible personal superannuation contributions made by an individual during those years.

1.18 The maximum Government co-contribution remains at $1,500 for eligible personal superannuation contributions made in the 2004-05, 2005-06, 2006-07, 2007-08 and 2008-09 income years by individuals with incomes under the lower income threshold. The maximum co-contribution in those years will continue to be reduced by 5 cents for each dollar by which the individual's total income exceeds the lower income threshold in the relevant year.

1.19 For the 2009-10 and later income years, the Government co-contribution matching rate will be equal to 100 per cent of the eligible personal superannuation contributions made by an individual during those years.

1.20 For eligible personal superannuation contributions made in the 2009-10 and later income years the maximum Government co-contribution will be $1,000 for individuals with incomes below the lower income threshold. The maximum co-contribution payable will be reduced by 3.333 cents for each dollar by which the individual's total income exceeds the lower income threshold in the relevant year.

Example 1.1

Jane works for Lemon Pty Ltd. In 2010-11 she makes a personal contribution into superannuation of $1,000 and does not claim a deduction for this contribution. Her assessable income for that year is $30,000 and she has no reportable fringe benefits or reportable employer superannuation contributions. The Commissioner of Taxation determines that Jane is eligible for a Government co-contribution and pays $1,000 into Jane's superannuation account.

Application and transitional provisions

1.21 These amendments will apply to the 2009-10 and later income years.

Chapter 2 - Thin capitalisation - modification of the rules in relation to the application of accounting standards for authorised deposit-taking institutions

Outline of chapter

2.1 Schedule 2 to this Bill modifies the thin capitalisation rules contained within Division 820 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the use of accounting and prudential standards for valuing certain assets of authorised deposit-taking institutions (ADIs).

2.2 This measure aims to adjust for certain impacts from the 2005 adoption of the Australian equivalents to International Financial Reporting Standards on an ADI's thin capitalisation position. It does this by adjusting the application of accounting and prudential standard treatment of specified assets.

2.3 This chapter outlines the circumstances in which certain assets are to be recognised by particular entities for thin capitalisation purposes. The relevant assets are:

•

treasury shares;

•

one component of the business asset excess market value over net assets - the EMVONA asset. The relevant component is the value of business in force at the time of acquisition of the relevant subsidiaries; and

•

capitalised software costs.

2.4 All references to legislative provisions in this chapter are references to the ITAA 1997 unless otherwise stated.

Context of amendments

2.5 The thin capitalisation rules in Division 820 are designed to ensure that Australian and foreign-owned multinational entities do not allocate an excessive amount of debt to their Australian operations thereby inappropriately reducing their Australian profits and tax. The thin capitalisation rules provide this by disallowing a proportion of otherwise deductible finance expenses (for example, interest) where the debt used to fund the Australian operations exceeds certain limits. The allowable level of debt for an ADI is calculated by reference to a minimum amount of equity capital.

2.6 Thin capitalisation rules use the accounting standards as the basis for the identification and valuation of assets, liabilities and equity capital. Prior to 2005, the relevant accounting standards were the Australian Generally Accepted Accounting Principles. However, from 1 January 2005 the Australian Generally Accepted Accounting Principles were replaced by the Australian equivalents to International Financial Reporting Standards. The adoption of Australian equivalents to International Financial Reporting Standards is regarded as having aligned Australia more closely with international accounting practice.

2.7 Transitional provisions were introduced to insulate affected entities, including ADIs, from potential adverse impacts on their thin capitalisation position from the 2005 adoption of the Australian equivalents to International Financial Reporting Standards. These transitional arrangements enabled entities to elect to apply the accounting standards as they existed immediately before 1 January 2005 (rather than the Australian equivalents to International Financial Reporting Standards) for a period of up to four income years from the first income year commencing on or after 1 January 2005. These arrangements are set out in section 820-45 of the Income Tax (Transitional Provisions) Act 1997.

2.8 Under subsection 820-45(4) of the Income Tax (Transitional Provisions) Act 1997, if an ADI makes a choice to use accounting standards that existed before 1 January 2005 (for an income year), the ADI must also choose to use the prudential standards in force under the Banking Act 1959 immediately before 1 January 2005 (rather than current prudential standards) for calculating amounts applicable to the ADI under Division 820.

2.9 The application of these transitional provisions began expiring from 1 January 2009.

2.10 The amendments in Schedule 2 implement the announcement in the 2009-10 Budget (Assistant Treasurer and Minister for Competition Policy and Consumer Affairs' Media Release No. 048 of 12 May 2009). In that media release, the Government announced it would introduce changes to the thin capitalisation regime for ADIs.

2.11 The amendments effectively establish the framework to apply on expiration of the current transitional arrangements and will apply to relevant entities whether or not an entity elected to use the transitional provisions.

2.12 At the time the Australian equivalents to International Financial Reporting Standards was adopted, certain impacts of the new standards for taxpayers subject to the thin capitalisation regime were expected, however other outcomes were unexpected and could not be considered at that time.

2.13 This measure does not reflect an intention to neutralise, for the purposes of the thin capitalisation rules, all differences in outcomes between the previous and current accounting standards. It is not intended to provide entities with scope to artificially inflate their asset base to support higher gearing levels inconsistent with the broader intent of this regime.

Summary of new law

2.14 For income years commencing on or after 1 January 2009, ADIs will be able to deviate from the accounting standard treatment of certain assets and liabilities when doing their thin capitalisation calculations.

Comparison of key features of new law and current law

Detailed explanation of new law

Treasury shares

2.15 Treasury shares are equity instruments that an entity acquires in itself (AASB 132 Financial Instruments Presentation). The amount of treasury shares held must be disclosed separately either on the face of the balance sheet or in the notes (AASB 101 Presentation of Financial Statements).

2.16 The circumstances in which an entity can hold shares in itself are strictly limited under the Corporations Act 2001. However, within these limits it is common business practice for the subsidiary of a bank to invest in the parent company. Two examples of an entity holding treasury shares are:

•

life insurance company subsidiaries of the group holding equity in the parent bank as part of investment portfolios supporting policyholder liabilities; and

•

employee share plan arrangements where entities hold parent company shares as part of the consolidated group's employee share plan arrangements.

2.17 Under AASB 1038 Life Insurance Business, issued 17 November 1998, direct investments in a particular bank's shares by that company's life insurance subsidiary's statutory funds are recognised in the group's balance sheet at market value (that is, recognised as investments relating to the life insurance business). Consequently, under this accounting standard, this amount was included in the calculation of adjusted average equity capital.

2.18 Section 820-300 is modified so that, for the purposes of calculating the adjusted average equity capital for an income year, certain treasury shares in the entity will be treated as included in the ADI's equity capital to the extent that those shares are part of the entity's eligible tier 1 capital [Schedule 2, item 1, subsection 820-300(4)]. These treasury shares are both shares held by a group member to support liabilities to third parties (that is, policy holders) and shares that offset the accrued expense of a share-based compensation scheme (as described in paragraphs 34 and 35 of Australian Prudential Standard 111 Capital Adequacy: Measurement of Capital issued January 2008).

2.19 Section 820-300 is amended to substantively retain the treatment, for thin capitalisation purposes, of a direct investment in a particular bank's shares by that company's life insurance subsidiary which existed immediately before 1 January 2005.

Value of business in force

2.20 An ADI group may include a life insurance subsidiary. Where this is the case, the accounting and prudential treatment of the assets of the life insurance company are relevant to the calculation of the safe harbour capital amount for the group.

2.21 Under Australian Generally Accepted Accounting Principles and AASB 1038 Life Insurance Business, a life insurer was able to recognise as a separate asset (in its consolidated financial statements) the excess of the market value of interests in subsidiaries over the net amount of the assets and liabilities of those subsidiaries as recognised in the consolidated financial statements. This was known as the 'EMVONA' asset.

2.22 EMVONA may be valued using various methodologies, including valuation as a composition of acquired goodwill arising from acquisitions of subsidiaries, comprising:

•

the value of business in force at the time of acquisition, which includes the net present value of the expected distributable profits of business in force at that time;

•

the value of new business, which is the net present value of the expected distributable profits of business expected to be written over future periods of time; and

•

any changes in the value of business in force and value of new business since acquisition.

2.23 Prior to 1 January 2005, the value of business in force at the time of acquisition was treated as an asset for regulatory capital purposes and as such was deducted from total capital, but not from tier 1 capital. The value of new business was an intangible asset and a tier 1 prudential capital deduction. Consequently, the value of business in force did not increase safe harbour capital amount. The value of new business did.

2.24 The amendment to the safe harbour capital amount method statement reduces the minimum amount of equity capital that an ADI must hold to meet thin capitalisation requirements. The minimum amount is reduced by the amount of goodwill or intangible assets recorded in the financial accounts of an entity that are attributable to the acquisition of a life company's subsidiary which relates to the EMVONA asset and is referrable to the value of business in force at the time of acquisition. This represents a divergence from current accounting practice and a reinstatement of the treatment under the Australian Generally Accepted Accounting Principles. [Schedule 2, items 4 and 7, section 820-310 (step 3(d) in the method statement) and subsection 820-680(1)(note)]

2.25 That is, the value of business in force at acquisition that forms part of the EMVONA asset is the relevant amount for the purposes of step 3(c) in the method statement. Any changes in the value of business in force post acquisition are ignored. The adjusted amount of regulatory capital may be included in the value of business in force at the time of acquisition. However as it is not part of EMVONA it too falls outside the exclusion in step 3(c) of the safe harbour capital amount method statement . [Schedule 2, items 4, 6 and 8, section 820-310 (step 3(c) in the method statement), subsection 820-310(2) and the definition of value of business in force in subsection 995-1(1)]

2.26 The amount of goodwill or intangible asset that relates to the EMVONA asset must be adjusted to reflect any impairment of the class of assets comprising the life company business of the ADI group. In turn this impairment limits the amount of the goodwill or intangible asset that can relate to EMVONA or the value of business in force. [Schedule 2, item 4, section 820-310 (step 3(c) in the method statement)]

2.27 The value of business in force at acquisition is the amount calculated by an actuary according to Australian actuarial practice. If the prescribed actuarial calculation is not undertaken, the value of business in force will be nil . [Schedule 2, item 6, section 820-310]

Example 2.1 : Life company acquired on 1 July 2001

On 1 July 2001, Bank Group Ltd indirectly acquired through another of its life insurance company subsidiaries 100 per cent interest in Life Co Ltd, which carried on Australian life insurance business. At the time of the acquisition Bank Group Ltd prepared financial statements in accordance with Australian Generally Accepted Accounting Principles.

Under Australian Generally Accepted Accounting Principles, the consolidated accounts of Bank Group Ltd recognised an EMVONA asset.

Based on an actuarial assessment prepared at the time of acquisition by an Accredited Member of the Institute of Actuaries of Australia in accordance with Actuarial Guidance Notes 225 and 552, Life Co Ltd was valued as explained in Table 2.1.

Table 2.1 : Valuation of Life Co Ltd: 1 July 2001

Component	Description	Amount $m
Net assets acquired	Net tangible assets recognised in the accounts of Life Co Ltd.	$1,604
Value of business in force	The value of the existing business in force, being the net present value of the expected distributable profit of business in force at the time of acquisition.	$2,412
Value of new business	The value of new business, being the net present value of the expected profits of the new business to be written over future periods of time.	$2,493
Total value	Total value of Life Co Ltd on the date of acquisition.	$6,509

The consolidated accounts of Bank Group Ltd therefore recognised EMVONA of $4,905 as at 30 June 2002, being the sum of the value of business in force and the value of new business at that date ($2,412 + $2,493 = $4,905).

On 1 July 2001 the value of business in force was $2,412.

Based on an actuarial assessment of the value of Life Co Ltd at 30 June 2002 by an Accredited Member of the Institute of Actuaries of Australia in accordance with Actuarial Guidance Notes 225 and 552, Life Co Ltd was valued as explained in Table 2.2.

Table 2.2 : Valuation of Life Co Ltd: 30 June 2002

Component	Description	Amount $m
Net assets acquired	Net tangible assets recognised in the accounts of Life Co Ltd.	$1,604
Value of business in force	The value of the existing business in force, being the net present value of the expected distributable profit of business in force at the time of acquisition.	$2,412
Value of new business	The value of new business, being the net present value of the expected profits of the new business to be written over future periods of time.	$2,493
Change in the value of business in force and the value of new business	The net change in value of the value of business in force and the value of new business.	$219
Total value	Total value of Life Co Ltd as at 30 June 2002.	$6,728

The value of business in force at the time of acquisition at 30 June 2002 was $2,412. It does not include the $219 change in the value of the value of new business and the value of business in force.

For the year ending 30 June 2002, Bank Group Ltd, under the Australian Prudential Regulation Authority's (APRA's) regulatory regime that operated at that time, was required to treat the value of new business amount of $2,493 as a tier 1 prudential capital deduction. The value of business in force at acquisition amount of $2,412 was deducted from total capital. It was not a tier 1 prudential capital deduction.

For the year ending 30 June 2002, the safe harbour capital amount of Bank Group Ltd does not include the value of business in force amount of $2,412 in the safe harbour capital amount.

Example 2.2 : Life company acquired on 1 July 2011

On 1 July 2011 Savings Group Ltd indirectly acquires through another life insurance company subsidiary a 100 per cent interest in Insurance Co Ltd, which carries on Australian life insurance business. At the time of the acquisition, Savings Group Ltd prepares its accounts in accordance with the Australian equivalents to International Financial Reporting Standards.

Under the Australian equivalents to International Financial Reporting Standards, the consolidated accounts of Savings Group Ltd do not recognise an EMVONA asset in relation to the holding of Insurance Co Ltd. The value of business in force in relation to the acquisition of Insurance Co Ltd is not separately identified. However, this amount is included in the 'goodwill or intangible assets' of the group.

If, at the time of acquisition of Insurance Co Ltd, an actuarial valuation of the company was undertaken by an Accredited Member of the Institute of Actuaries of Australia in accordance with Actuarial Guidance Notes 225 and 552, then those values may be used for the purposes of Savings Group Ltd thin capitalisation calculations.

The valuation must identify the EMVONA component of Insurance Co Ltd and the value of business in force of Insurance Co Ltd at the time of the acquisition. Insurance Co Ltd was valued as explained in Table 2.3.

Table 2.3 : Valuation of Life Co Ltd: 1 July 2011

Component	Description	Amount
Net assets acquired	Net tangible assets recognised in the accounts of Insurance Co Ltd.	$6,805
Value of business in force	The value of the existing business in force, being the net present value of the expected distributable profit of business in force at the time of acquisition.	$5,911
Value of new business	The value of new business, being the net present value of the expected profits of the new business to be written over future periods of time.	$3,493
Total value	Total value of Insurance Co Ltd on the date of acquisition.	$16,209

The value of business in force at 1 July 2011 is $5,911.

For the year ending 30 June 2012, Savings Group Ltd, will have a value of business in force at acquisition of $5,911. Under APRA's regulatory regime (assuming it remains unchanged), it will be a tier 1 prudential capital deduction

For the year ending 30 June 2012, the safe harbour capital amount of Savings Group Ltd excludes the value of business in force at acquisition of $5,911 from the safe harbour capital amount.

For the year ending 30 June 2013 the class of assets that includes the investment in Insurance Co Ltd (which in turn includes the value of business in force) is impaired by $3,000. This represents a 50 per cent reduction in that class of assets from the previous year. The goodwill or intangible assets recorded in the accounts of Savings Group Ltd are to be adjusted to reflect this impairment. Therefore on 30 June 2003 the value of business in force at acquisition, will be $2,955.50 (0.5 × $5,911).

Capitalised software expenses

2.28 Under Australian Generally Accepted Accounting Principles, capitalised software costs that were identified as 'other assets' and not intangible assets were treated as risk-weighted assets and increased the safe harbour capital amount required to be held by 4 per cent of their value.

2.29 Australian equivalents to International Financial Reporting Standards AASB 138: Intangible Assets treats all capitalised software costs as intangible assets. Intangible assets are a tier 1 prudential capital deduction and as such, in the absence of this amendment, would reduce the safe harbour capital amount by 100 per cent of their value.

2.30 The safe harbour method statement in section 820-310 is amended to substantively retain the treatment of capitalised software costs under the accounting and prudential standards that existed immediately before the Australian equivalents to International Financial Reporting Standards were adopted.

2.31 That is, intangible assets referrable to capitalised software costs are not treated as a tier 1 prudential capital deduction as they are excluded from step 3 of the safe harbour capital amount method statement in section 820-310. Capitalised software costs retain risk-weighted asset treatment and increase the safe harbour capital amount required to be held by 4 per cent of their value by virtue of their inclusion at step 1 of that method statement . [Schedule 2, items 3 and 4, section 820-310 (step 1 in the method statement), section 820-310 (step 3(d) in the method statement)]

Requirement to use accounting standards

2.32 Subsection 820-680(1) requires an entity to comply with the accounting standards in identifying its assets and liabilities and in determining the value of its assets, liabilities and equity. The note following subsection 820-680(1) refers to provisions which modify this requirement. That note is amended to include the changes made by this Schedule to the treatment of the value of business in force component of the 'EMVONA' asset . [Schedule 2, item 7, subsection 820-680(1)(note)]

Application and transitional provisions

2.33 The transitional arrangements in the Income Tax (Transitional Provisions) Act 1997 cease to apply for income years commencing on or after 1 January 2009. The amendments made by this Schedule apply to assessments for each income year starting on or after 1 January 2009 . [Schedule 2, item 9]

Chapter 3 - Transactions involving security and intelligence agencies

Outline of chapter

3.1 Schedule 3 to this Bill amends the tax law to provide the heads of the Australian Security Intelligence Organisation and the Australian Secret Intelligence Service with the power to declare that Commonwealth tax laws do not apply to a specified entity in relation to a specified transaction. This ensures that the tax authorities will not need to obtain information that should remain secret in the interests of national security.

Context of amendments

3.2 Under current tax law, the administrative obligations on tax authorities can require them to seek information that, for reasons of Australia's national security, is very sensitive and should remain confidential. In practice, the tax authorities have usually respected requests from the security and intelligence agencies not to seek such information but there are doubts whether complying with such requests would always be legally justified.

Summary of new law

3.3 These amendments grant a power to the Director-General of Security and the Director-General of the Australian Secret Intelligence Service to declare that a specified entity is not subject to Commonwealth tax laws in relation to a specified transaction. Making a declaration about a transaction will mean that the tax authorities will not need to seek information about that transaction and so will not have to choose between observing their obligations under the tax laws and preserving Australia's national security interests.

Comparison of key features of new law and current law

Detailed explanation of new law

3.4 Situations can arise where transactions entered into in connection with the operational activities of Australia's security and intelligence agencies could attract taxation consequences. In working out how the tax laws apply to those transactions, the tax authorities may need information that should be kept secret in the interests of Australia's national security. This can result in a conflict between the interests of national security and the tax law.

3.5 While these conflicts have been managed till now by the tax authorities taking a reasonable approach when asked to by the security and intelligence agencies, it would be preferable to provide legislative guidance to deal with these cases.

3.6 These amendments address the conflicts by giving the heads of the relevant security and intelligence agencies the power to declare that specified entities are not subject to Commonwealth tax laws in relation to specified transactions. The result will be that the tax authorities will not need to seek information about entities in relation to transactions subject to a declaration . [Schedule 3, item 1, subsection 850-100(1)]

3.7 Unless otherwise specified, legislative references in this chapter are to provisions in Schedule 1 to the Taxation Administration Act 1953.

Making a declaration

3.8 A declaration can be made by the Director-General of Security or by the Director-General of the Australian Secret Intelligence Service [Schedule 3, item 1, subsections 850-100(2) and (3)]. To make a declaration, they must be satisfied that it is necessary for the proper performance of the functions (respectively) of the Australian Security Intelligence Organisation or the Australian Secret Intelligence Service [Schedule 3, item 1, subsection 850-100(4)].

3.9 A declaration must be made in writing and must be signed by the relevant Director-General [Schedule 3, item 1, subsection 850-100(5)]. It must also specify one or more entities and one or more transactions. It is not enough to specify an entity without also specifying a transaction, or vice versa [Schedule 3, item 1, subsections 850-100(2) and (3)].

Entities

3.10 'Entity' is a widely defined term (see subsection 960-100(1) of the Income Tax Assessment Act 1997 (ITAA 1997)). It includes individuals, corporations, trusts, partnerships, superannuation funds and bodies politic. It is not necessary for a declaration to name a particular entity; it can specify a class of entities (see subsection 46(3) of the Acts Interpretation Act 1901). For instance, a declaration would sufficiently specify an entity if it said that it applied to the parties to a specified transaction.

3.11 These amendments make it clear that a declaration can specify the Australian Security Intelligence Organisation or the Australian Secret Intelligence Service as entities . [Schedule 3, item 1, subsections 850-100(2) and (3)]

3.12 The specified entity need not still exist when the declaration is made. For instance, a declaration could specify a deceased individual or a liquidated company . [Schedule 3, item 1, paragraph 850-100(6)(b)]

Transactions

3.13 A declaration must specify a transaction. As with entities, it can do that by specifying a class of transactions instead of naming a particular transaction (see subsection 46(3) of the Acts Interpretation Act 1901).

3.14 A declaration can specify a transaction that has already happened before the declaration is made [Schedule 3, item 1, paragraph 850-100(6)(a)]. It does not matter that the specified transaction happened before these amendments commence [Schedule 3, item 1, subsection 850-100(4)].

Revoking a declaration

3.15 The Directors-General also have the power to revoke or vary any declaration they have made (see subsection 33(3) of the Acts Interpretation Act 1901).

Effect of a declaration

3.16 For an entity specified in a declaration, the specified transactions are disregarded in determining the entity's tax-related liabilities under any Commonwealth law [Schedule 3, item 1, paragraph 850-100(8)(a)]. The transactions are also disregarded in determining the entity's entitlement to any tax-related benefit under any Commonwealth law [Schedule 3, item 1, paragraph 850-100(8)(b)].

Example 3.1 : Entity not liable to taxation or entitled to refund

A declaration is stated as applying the exempting provisions to a service that James pays Jack to provide. The result is that Jack and James are not liable for taxation or entitled to any tax credit or refund in relation to their transaction. Jack will not treat the payment as assessable income for income tax purposes and will not pay goods and services tax (GST) for providing the service. James will not be able to deduct the payment for income tax purposes, will not be liable for any superannuation guarantee charge in relation to the payment, and will not be entitled to any input tax credit for GST purposes.

3.17 These effects of a declaration apply even to tax consequences that a provision of a law says can only be exempted by another provision if it expressly says that it is providing an exemption from that consequence . [Schedule 3, item 1, paragraph 850-100(8)(a)]

3.18 These amendments are drafted that way (as opposed to expressly mentioning particular consequences) to ensure that all provisions of that sort are covered. Current examples of 'exemption limitation' provisions covered by the amendments are:

Table 3.1 : Exemption limitation provisions covered

An amount of ordinary income (such as wages) that is excluded from being assessable income will usually be exempt income for income tax purposes (see subsection 6-20(2) of the ITAA 1997). Exempt income can reduce the recipient's income tax losses of previous years (see Division 36 of the ITAA 1997). Amounts arising under a transaction specified in a declaration do not have that effect because the transaction is disregarded in working out tax-related liabilities and benefits, including the effect of a tax loss . [Schedule 3, item 1, subsection 850-100(6)]

3.21 For an entity specified in a declaration, the specified transactions are also disregarded in determining whether the entity has any rights or obligations in relation to tax-related liabilities or benefits. If it does, the transactions are ignored in determining the extent of those rights and obligations . [Schedule 3, item 1, paragraph 850-100(8)(c)]

Example 3.2 : Entity not liable to taxation or entitled to refund

Continuing the previous example, Jack's and James' transaction is ignored in working out whether James has to withhold any part of his payment to Jack or whether either of them has to keep records about the transaction.

Miscellaneous aspects of declarations

Legislative instruments

3.22 A declaration would probably be a legislative instrument within the meaning of the Legislative Instruments Act 2003. That Act requires that legislative instruments, unless exempt, be registered on the Federal Register of Legislative Instruments (see section 24 of that Act) and to be tabled in Parliament (see section 38 of that Act), and would usually result in the instrument ceasing to apply after 10 years (see section 50 of that Act). Those outcomes would not be appropriate for reasons of national security and personal privacy. Declarations will necessarily contain sensitive operational information and personal information, which should not be publicly disclosed. For that reason, these amendments provide that the declarations are not legislative instruments and are therefore exempt from the requirements of the Legislative Instruments Act 2003. [Schedule 3, item 1, subsection 850-100(9)]

Evidence

3.23 Something that purports to be a signed declaration is to be taken to be a properly made declaration in the absence of evidence to the contrary. That avoids the possibility that the tax authorities would need to seek information to satisfy themselves that a declaration was validly made before giving effect to it . [Schedule 3, item 1, subsection 850-100(7)]

3.24 The Inspector-General of Intelligence and Security provides independent assurance for ministers and Parliament as to whether Australia's security and intelligence agencies are acting legally and with propriety by inspecting, inquiring into and reporting on their activities. It would be inconsistent with the proper performance of that function for the Inspector-General to be required to presume that the declarations were properly made. Therefore, the presumption does not apply to the activities of the Inspector-General . [Schedule 3, item 1, subsection 850-100(7)]

Oversight

3.25 As well as being reviewed by the Inspector-General of Intelligence and Security, who is appointed under the Inspector-General of Intelligence and Security Act 1986, the making of declarations will be generally overseen by the Parliamentary Joint Committee on Intelligence and Security. That committee is established under section 28 of the Intelligence Services Act 2001 and has among its functions, reviewing the administration and expenditure of the security and intelligence agencies (see paragraph 29(1)(a) of that Act).

Application and transitional provisions

3.26 These amendments apply from commencement on Royal Assent [Clause 2, item 3 in the table]. However, a declaration can be made in relation to a transaction that occurred before commencement [Schedule 3, item 1, subsection 850-100(6)].

Chapter 4 - Special Disability Trusts - changes to the taxation of unexpended income

Outline of chapter

4.1 Schedule 4 to this Bill amends Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936) so that the unexpended income of a Special Disability Trust (SDT) is taxed at the relevant principal beneficiary' personal income tax rate rather than automatically at the top personal tax rate plus the Medicare levy.

4.2 All legislative references in this chapter are made to the ITAA 1936 unless otherwise specified.

Context of amendments

4.3 In 2006, SDTs were introduced to assist families and carers to make private financial provision for the current and future care and accommodation needs of a family member with severe disability - referred to as the principal beneficiary. The benefits of establishing these trusts are a gifting concession of up to $500,000 combined for eligible family members of the principal beneficiary and an assets test exemption of up to $551,750 indexed annually for the principal beneficiary. In order to access these concessions the trust must be established in accordance with Part 3.18A of the Social Security Act 1991.

4.4 These amendments ensure that the taxation of the unexpended income of a trust is not a disincentive to the establishment of an SDT.

4.5 SDTs are currently taxed in accordance with the general rules for the taxation of trusts in Division 6 of the ITAA 1936. Whether the beneficiary or the trustee pays tax under these rules depends on a range of factors, including whether the beneficiary is presently entitled to a share of the income of the trust and whether they are under a legal disability.

4.6 Broadly, the principal beneficiary of an SDT is deemed to be presently entitled to the income of the SDT that is expended for their care and accommodation, in accordance with section 101. This amount is then included in the assessable income of the principal beneficiary under section 97 if they are a resident, or section 98A if they are a non-resident where they are not under a legal disability. Alternatively, if the principal beneficiary is deemed to be presently entitled to the income of the SDT and is under a legal disability, the trustee of the SDT is assessed on their behalf under section 98.

4.7 Where the income of an SDT is not fully expended on the care and accommodation of the principal beneficiary, this unexpended income is retained in the trust. The trustee of the trust is assessed on this income under section 99A at penalty rates of tax - being 46.5 per cent.

4.8 On 15 May 2008 the Senate referred a number of matters relating to SDTs to the Community Affairs Committee for inquiry and report by 18 September 2008, including:

•

why more families of dependents with disabilities are not making use of the current provisions to establish SDTs;

•

the effectiveness of Part 3.18A of the Social Security Act 1991;

•

barriers in the relevant legislation to the establishment of SDTs; and

•

possible amendments to the relevant legislation.

4.9 In its report, which was tabled on 16 October 2008, the Committee highlighted that the tax arrangements that apply to SDTs diminish their value for carers and people with disabilities.

4.10 As part of the 2009-10 Budget the Government announced that it would tax the unexpended income of an SDT at the principal beneficiary's personal income tax rate rather than at the top personal tax rate plus the Medicare levy.

4.11 These amendments address one of the tax issues identified by the Senate Standing Committee on Community Affairs and are designed to ensure that taxation is not a disincentive to the establishment of an SDT.

Summary of new law

4.12 These amendments ensure that from the 2008-09 income year all of the net income of an SDT is brought to tax at the marginal tax rate of the principal beneficiary of that SDT.

4.13 To achieve this result, these amendments provide that the net income of an SDT is, in the first instance, assessed to the trustee of the trust. The entire amount of the net income of the SDT may then be included in the assessable income of the principal beneficiary. To ensure that the net income of the SDT is not effectively taxed twice, an offset is provided to the principal beneficiary for the amount of tax paid or payable by the trustee where the net income of the SDT is also assessed to the principal beneficiary.

Comparison of key features of new law and current law

Detailed explanation of new law

4.14 In order to ensure that all of the net income of an SDT is taxed at the marginal tax rate of the principal beneficiary, these amendments make a number of modifications to the operation of Division 6.

Eligibility for these modifications

4.15 The modifications made by these amendments to Division 6 only apply in relation to a year of income where a trust estate is an SDT at the end of the income year . [Schedule 4, item 3, subsection 95AB(1)]

Example 4.1

Andrea is an elderly single parent who has a son John, who is severely disabled. During the 2008-09 income year Andrea decides to establish an SDT in order to provide for John's future care and accommodation.

The SDT is established on 1 June 2009. It is assessed taking into account the modifications to Division 6 provided for in section 95AB for the entire 2008-09 income year.

4.16 Where a trust estate is not an SDT at the end of an income year the trust estate is subject to the ordinary operation of Division 6.

Example 4.2

On 1 January 2009, Casey, who is the principal beneficiary of the Ackroyd SDT, passes away. Due to Casey's death, the Ackroyd SDT ceases to be a complying SDT as the trust does not have a principal beneficiary.

The net income of the Ackroyd trust is assessed in accordance with the ordinary operation of Division 6 for the entire 2008-09 income year.

Present entitlement to the income of an SDT

4.17 Division 6 relies on the concept of present entitlement in order to determine how and to whom the net income of a trust is assessed. Under Division 6, a beneficiary is only assessable on a share of the trust's net income if they are presently entitled to a share of the income of the trust estate. If there is a share of the income of the trust estate to which no beneficiary is presently entitled, the trustee of the trust is assessed on that share of the net income of the trust under section 99A or (where applicable) section 99.

4.18 As the Social Security Act 1991 currently places a number of restrictions upon how the income of an SDT can be applied, it is common for the principal beneficiary of an SDT not to be presently entitled to all of the income of the SDT. The result under the current law is that a portion of the net income of the trust remains in an SDT at the end of the income year and is assessed to the trustee at penalty rates under section 99A, reducing the amount that can be applied for the future care and accommodation of the principal beneficiary.

4.19 These amendments treat the principal beneficiary of an SDT as if they are presently entitled to all of the income of the SDT. This change ensures that there is no net income of an SDT that is assessed to the trustee under section 99A, even where income is retained in the trust at the end of the income year, increasing the amount available for the care and accommodation of the principal beneficiary in future income years . [Schedule 4, item 3, subsection 95AB(2)]

Example 4.3

Sammy and Scott are an elderly couple. Their daughter Rachel is severely disabled. Sammy and Scott establish an SDT in order to provide for Rachel's care and accommodation needs.

In the 2008-09 income year, the SDT has income of $15,000. The SDT's net income is also $15,000. The trustee of the SDT applies $10,000 for Rachel's reasonable care and accommodation costs and retains the remaining $5,000 in the trust.

Rachel is deemed to be presently entitled to all of the $15,000 of the trust's income for the 2008-09 income year although $5,000 of the income is retained in the trust.

SDT has no income for an income year

4.20 Currently where a trust does not have any trust income for the purposes of section 97 or 98, but has net income as defined under the tax law, the trustee of the trust is assessed under section 99A on the whole of the net income of the trust.

4.21 These amendments ensure that where an SDT has no trust income but has net income, the SDT is treated as if it has income. In addition, where paragraph 95AB(4)(a) operates to treat the trust as if it has income, the principal beneficiary of the SDT is treated as being presently entitled to all of that income . [Schedule 4, item 3, paragraph 95AB(4)(b)]

4.22 This treatment ensures that the trustee of an SDT is not assessed under section 99A, ensuring that the whole of the net income of the SDT is assessed at the marginal tax rate of the principal beneficiary . [Schedule 4, item 3, subsection 95AB(4)]

Example 4.4

Andrew is the principal beneficiary of the Walker SDT.

In the 2008-09 income year, the Walker SDT has no trust income but has net income of $5,000 from the sale of a parcel of shares.

Although the trust does not have any income for the 2008-09 income year, it is treated as if it has income for the purposes of Division 6.

In addition, Andrew is treated as if he is presently entitled to all of the income of the trust.

Resident principal beneficiary treated as being under a legal disability

4.23 In order to tax the unexpended income of an SDT at the marginal tax rate of the principal beneficiary, these amendments ensure that the income of the SDT is in the first instance assessed to the trustee of the trust and then (in relevant circumstances) to the principal beneficiary of the trust.

4.24 This approach to taxing a trust's net income currently applies under subsection 98(3) and section 98A where a beneficiary is a non-resident at the end of an income year and under subsection 98(1) and section 100 where a beneficiary is under a legal disability and has income from other sources (or is a beneficiary in more than one trust).

4.25 There is no mechanism in the existing law that allows this approach to be adopted where the beneficiary of a trust is a resident and is not under a legal disability. In order to tax the income of an SDT at the marginal tax rate of the principal beneficiary, these amendments treat principal beneficiaries of SDTs, who are residents at the end of the income year, as if they are under a legal disability for the purposes of Division 6 . [Schedule 4, item 3, subsection 95AB(3)]

4.26 This treatment ensures that the net income of an SDT is always taxed to the trustee in the first instance under subsection 98(1) and then if appropriate, included in the principal beneficiary's assessable income under section 100 along with any relevant tax offset.

Example 4.5

Rummana is an Australian resident and is not under a legal disability. She is the principal beneficiary of the Chang SDT for the 2008-09 income year.

The Chang SDT has income (and net income) of $10,000 for the 2008-09 income year. Pursuant to the trust's deed, $5,000 is applied for Rummana's reasonable care and accommodation costs. The remaining $5,000 is accumulated in the trust.

Rummana is treated as if she is presently entitled to the entire income of the Chang SDT and under a legal disability. Consequently, the trustee of the Chang SDT is assessed on the entire $10,000 of net income in accordance with subsection 98(1).

Offset for an amount paid or payable by the trustee of an SDT

4.27 Under the existing law, where both the trustee and beneficiary of a trust are assessed on all or part of the net income of a trust, an offset is provided to the beneficiary for the tax paid or payable by the trustee. In particular, where the trustee is assessed under subsection 98(1) and the beneficiary under section 100, an offset is available to the beneficiary under subsection 100(2). This avoids double taxation.

4.28 Where the amount of tax paid by the trustee of a trust, on behalf of the beneficiary under subsection 98(3) exceeds the beneficiary's individual tax liability under subsection 98A(1), the Commissioner of Taxation (Commissioner) is obliged to pay to the beneficiary an amount equal to the difference between the two amounts in accordance with paragraph 98A(2)(b). Currently there is no requirement for the Commissioner to make such a payment in relation to the offset provided for under subsection 100(2).

4.29 To ensure that all of the net income of an SDT is taxed at the marginal tax rate of the principal beneficiary, subsection 95AB(5) of these amendments provides for an appropriate portion of the offset available to the principal beneficiary to be refunded where the tax assessed to the beneficiary is less than the amount of tax the trustee is liable to pay under subsection 98(1). The refundable amount, determined under subsection 95AB(5), is subject to the existing refundable tax offset rules in Division 67 of the Income Tax Assessment Act 1997.

Example 4.6

In the 2008-09 income year, Mark is the principal beneficiary of the Lang SDT. Mark is a resident, is not under a legal disability and has a part-time job during the 2008-09 income year from which he earns $5,000.

During the 2008-09 income year, the Lang SDT earns income of $25,000. The net income of the trust is also $25,000.

The trustee of the Lang SDT applies $20,000 for Mark's reasonable care and accommodation costs during the income year and retains the remaining $5,000 in the trust.

Mark is treated as if he is presently entitled to all of the income of the Lang SDT and under a legal disability. The trustee of the Lang SDT is therefore assessed on the entire $25,000 in accordance with subsection 98(1). However as Mark has also derived income from his part-time employment, he is required to include the entire income of the SDT in his assessable income under subsection 100(1).

Mark is assessed on $30,000 at his marginal rates of tax for the 2008-09 income year. He is also able to offset any tax paid or payable by the trustee of the Lang SDT on the $25,000 of trust net income against his individual assessment.

Before the 2008-09 income year Mark would have been assessed on $25,000 at his marginal rates of tax and the trustee of the Lang SDT would have been assessed on $5,000 at 46.5 per cent.

Example 4.7

In the 2008-09 income year, Maria is the principal beneficiary of the Barker SDT. She is a under a legal disability and is an Australian resident. She derives $5,000 of income during the 2008-09 income year from other sources.

The Barker SDT has income of $35,000 for the 2008-09 income year. The net income of the trust is also $35,000. The trustee of the Barker SDT applies $20,000 for Maria's reasonable care and accommodation costs and retains $15,000 in the trust.

As a result of these amendments, the trustee of the Barker SDT is assessed on the entire $35,000 under subsection 98(1). However as Maria has also derived income from other sources she is required to include the entire income of the SDT in her assessable income.

Maria is assessed on $40,000 at her marginal rates of tax for the 2008-09 income year. She is also able to offset any tax paid or payable by the trustee of the Barker SDT on the $35,000 of trust net income against her individual assessment.

Before the 2008-09 income year Maria would have been assessed on $25,000 at her marginal rates of tax and the trustee of the Barker SDT would have been assessed on $15,000 at 46.5 per cent.

Minor principal beneficiaries

4.30 Under the existing law, principal beneficiaries of SDTs who are minors are generally treated as excepted persons under section 102AC. These amendments put this outcome beyond doubt and ensure that all minors who are the principal beneficiaries of SDTs are excepted persons for the purposes of section 102AC . [Schedule 4, item 4, paragraph 102AC(2)(d)]

Application and transitional provisions

4.31 These amendments apply for the 2008-09 income year and later income years . [Schedule 4, item 8]

Chapter 5 - Definition of a managed investment trust

Outline of chapter

5.1 Schedule 5 to this Bill makes amendments to Subdivision 12-H of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) which applies for withholding tax purposes.

5.2 This Schedule:

•

amends Subdivision 12-H of Schedule 1 to the TAA 1953 dealing with the definition of a 'managed investment trust' (MIT); and

•

makes consequential amendments to Division 275 of the Income Tax Assessment Act 1997 (ITAA 1997).

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

Context of amendments

5.4 The MIT withholding tax rules were enacted by Subdivision 12-H of Schedule 1 to the TAA 1953. The rules were enacted by the Tax Laws Amendment (Election Commitments No. 1) Act 2008.

5.5 These rules specify the definition of a MIT for the purpose of pay as you go (PAYG) withholding on certain fund payments to foreign residents.

5.6 The intention of the MIT withholding tax regime - to enhance the competitiveness of the Australian managed funds industry in attracting future foreign investment - is achieved by subjecting most foreign investors to a reduced rate of final withholding tax (currently 15 per cent) on fund payments from the MIT. This rate will fall to a 7.5 per cent final withholding tax for fund payments in respect of the income year beginning on or after 1 July 2010.

5.7 The reduced withholding tax rates only apply where the investor is a resident of a country with which Australia has effective exchange of information on taxation matters. In other cases, the rate is 30 per cent.

5.8 Dividends, royalties and interest payments are specifically excluded from being fund payments. Implicitly, fund payments are other Australian sourced income derived from passive investments.

5.9 The Government announced amendments to the definition of a MIT in the Assistant Treasurer's Media Release No. 020 of 10 February 2010. On that day, the Government introduced amendments to the ITAA 1997 to provide for a capital account election mechanism for trusts that are MITs (the MIT capital measure). For the purpose of the capital measure, a trust that is a MIT (as defined in the TAA 1953) is a MIT for capital account treatment.

5.10 The current definition of a MIT for withholding tax purposes precludes some wholesale funds from being treated as a MIT. Provided genuine wholesale funds are subject to regulation in Australia and are appropriately widely held, it is appropriate for these trusts to be MITs for withholding tax purposes and for their foreign resident investors to receive the benefit of the reduced withholding tax rates.

5.11 The Government, in furthering its objective to secure Australia's position as a financial services centre, is amending the definition of a MIT to ensure that certain widely held wholesale managed investment schemes (MISs) and government-owned MISs, are able to qualify as MITs under new rules applying to these funds.

5.12 In addition, new rules will apply to ensure the MIT withholding tax rules are operating as originally intended. The first new rule is the introduction of a trading business test to ensure that Australian active businesses (operating through any structure) are not at a competitive disadvantage. This is also consistent with the policy basis that the MIT definition is aimed at covering only collective investment vehicles that predominantly undertake passive investment.

5.13 Secondly, in line with ensuring the provisions are operating as originally intended, the MIT definition will be limited to qualifying trusts where the investment management activities in relation to the trust are carried out in Australia. The focus of this test is on the investment decisions (and related activities) that are generally undertaken by the manager of the fund. Such decisions relate to the type of, and timing of the purchase of, investment assets.

5.14 This change is designed to ensure that one of the original objectives of the MIT withholding rules - to enhance the competitiveness of the Australian funds management industry - is met. As this policy objective is not as relevant for the MIT capital measure (which is directed more towards increasing certainty for investors and managed funds), this rule will not apply for the purposes of that measure.

5.15 Thirdly, consistent with the objective of both the MIT withholding tax rules and the MIT capital measure, a further change will ensure only genuinely widely held trusts are able to qualify as a MIT. This will be achieved through introducing an exclusion for closely held trusts.

Summary of new law

5.16 Schedule 5 makes amendments to the definition of a MIT for withholding tax purposes. A MIT, as defined in subsection 995-1(1) of the ITAA 1997, has the meaning given by section 12-400. The amended definition will also apply for the purposes of the rules dealing with deemed capital account treatment for MITs in Division 275 of the ITAA 1997.

5.17 These amendments extend the definition of a MIT to allow certain MISs that are not required to be registered under the Corporations Act 2001 because they provide financial services to wholesale clients (unregistered wholesale funds) to qualify as a MIT, provided other requirements to be a MIT are satisfied.

5.18 The amendments also extend the definition of a MIT to allow a MIS that is unable to register under the Corporations Act 2001 because it is operated by an entity in the capacity of the Crown (government-owned), to qualify as a MIT. Likewise, a wholesale MIS that is operated or managed by an entity that is not required to be a financial services licensee because it is an entity in the capacity of the Crown may qualify as a MIT. The amendments will extend to cases where a MIS is operated or managed by an entity that is a wholly-owned subsidiary of a Crown entity and the Australian Securities and Investments Commission (ASIC) has issued an exemption instrument that has effect in relation to the entity and the operation of the MIS.

5.19 These amendments set out a new definition of MIT for both registered MISs (those registered under the Corporations Act 2001 generally operated by a financial services licensee (as defined by section 761A of that Act) whose licence covers operating such a MIS) and unregistered MISs.

5.20 In the case of both registered MISs and unregistered wholesale MISs, the definition of a MIT is being amended to provide that, subject to satisfying other conditions, the trust must be:

•

an Australian resident trust;

•

a MIS (as defined by section 9 of the Corporations Act 2001); and

•

widely held.

5.21 These amendments introduce separate tests to determine whether a trust is widely held in the case of unregistered wholesale and registered MISs. Having a separate widely held test for each type of MIS is appropriate because holdings in each type of MIS, including direct and indirect holdings, are generally quite different.

5.22 Under the current law, a registered MIS may have qualified as 'widely held' (and therefore been able to qualify as a MIT) because of the rule dealing with membership held by a specified widely held entity (in subsection 12-400(2) of the current law). This rule is being repealed by amendments made in this Schedule and, consequently, such a registered MIS will no longer be considered widely held. However this is subject to a transitional rule (discussed in paragraph 5.28).

5.23 Further new rules will ensure the intended objectives of the MIT withholding tax rules, when originally introduced, are satisfied. A unit trust that would otherwise qualify as a MIT will no longer qualify if it is a trading trust for the purposes of Division 6C in Part III of the Income Tax Assessment Act 1936 (ITAA 1936). Any other trust will no longer qualify if, in the year of income, the trust carried on a trading business or controlled (or was able to control) directly or indirectly the affairs or operations of another person in respect of the carrying on by that other person of a trading business (within the meaning of Division 6C).

5.24 The effect of these additional requirements is to broaden the current exclusion that applies to public trading trusts and corporate unit trusts to all trading trusts.

5.25 Consistent with the original policy objectives underpinning the MIT withholding tax rules - to support the Australian funds management industry - the amendments provide that the investment management activities carried out throughout the income year in relation to the trust must be carried out in Australia. If this additional requirement is not met, the trust will not qualify as a MIT for the withholding tax rules but may still be treated as a MIT for the purposes of the MIT capital account treatment rules.

5.26 To add further integrity to the MIT withholding tax rules, a trust that breaches the closely held rules (being the small group closely held test and the foreign resident individual closely held test) will not be able to qualify as a MIT.

5.27 The amendments made by this Schedule apply for Subdivision 12-H purposes in relation to fund payments made in relation to the first income year starting on or after the first 1 July after Royal Assent.

5.28 However, in situations where a trustee of the trust made a fund payment before the introduction of this Bill to Parliament, the amended rules do not apply to that trust in relation to the 2010-11 through to 2014-15 income years. This preserves the status of the trust as a MIT if it qualified as a MIT before the amendments made by this Schedule to this Bill. This transitional rule only applies in respect of the MIT withholding tax rules.

5.29 The amended rules apply in relation to Division 275 of the ITAA 1997 (the MIT capital measure) in the same way as the amendments made by Schedule 3 to the Tax Laws Amendment (2010 Measures No. 1) Bill 2010. Generally, this is in relation to certain capital gains tax (CGT) events that happen on or after the start of the 2008-09 income year.

5.30 The amended definition of a MIT also applies to CGT events happening on or after 1 November 2008 for the purposes of Subdivision 126-G of the ITAA 1997.

Comparison of key features of new law and current law

Detailed explanation of new law

Extending the meaning of a MIT

5.31 The current definition of a MIT in item 2 of the table in subsection 12-400(1) requires that a MIS (as defined by section 9 of the Corporations Act 2001) be operated by a financial services licensee (as defined by section 761A of the Corporations Act 2001) whose licence covers operating such a MIS. In this context, the financial services licensee is a person who holds an Australian Financial Services Licence to operate the MIS.

5.32 This requirement in the current law was targeted at MISs that are registered under the Corporations Act 2001, which generally includes 'retail' funds but may also include some 'wholesale' funds - provided the funds are registered.

5.33 The current definition of MIT precludes some unregistered MISs (referred to as unregistered 'wholesale' funds) from qualifying as MITs. This is because an Australian Financial Services Licence to operate a MIS (through a licence to operate a scheme or a class of schemes) only covers what are commonly referred to as registered (retail) MISs.

5.34 While it is possible for the manager of an unregistered MIS to hold an Australian Financial Services Licence, the licence will not necessarily cover the operation of an unregistered scheme - that is, the current legislative requirement that the MIS be operated by a financial services licensee whose licence covers operating such a MIS will not be satisfied.

5.35 When Subdivision 12-H was inserted by the Tax Laws Amendment (Election Commitments No. 1) Act 2008, it was not intended that, as a general rule, MISs operating as 'wholesale' funds were to be excluded from the definition of a MIT.

5.36 Although the Corporations Law did not require unregistered wholesale funds to be operated as registered MISs, previously, subsection 601FC(4) of the Corporations Act 2001 prohibited a registered scheme (for example, a retail fund) from investing in a MIS that was not registered. Therefore, in practice, many wholesale funds did register under the Corporations Act 2001 in order to receive investment funds from the retail funds sector (even though the wholesale fund itself was not required to be registered). With the repeal of subsection 601FC(4) of the Corporations Act 2001, there is a reduced practical need for wholesale funds to be registered MISs.

5.37 Broadly, amendments made by this Schedule ensure that an Australian resident trust that is a MIS that is widely held (and that meets the other requirements to be a MIT) can qualify as a MIT. These are referred to as the general requirements for a trust to be a MIT (and are discussed in paragraphs 5.39 to 5.64) . [Schedule 5, item 4, subsection 12-400(1)]

5.38 Under the new definition of a MIT, the distinction between a registered MIS and an unregistered MIS becomes important in determining whether the trust is widely held, as different rules apply depending on the type of MIS. These are discussed as specific requirements for a registered MIS and for an unregistered MIS in paragraphs 5.65 to 5.74 and 5.75 to 5.98, respectively . [Schedule 5, item 4, paragraphs 12-400(1)(e) and (f)]

What are the general requirements for a trust to be a MIT ?

5.39 For any trust to qualify as a MIT in relation to an income year - whether a registered MIS under section 601EB of the Corporations Act 2001 or not - the following requirements must be satisfied:

•

at the time the trustee of the trust makes the first fund payment in relation to the income year, or at an earlier time in the income year the trust has a relevant connection with Australia;

•

at the time the payment is made, the trust is a MIS (as defined by section 9 of the Corporations Act 2001);

•

the trust is not a trading trust (for a unit trust) or carrying on a trading business (for any other trust) in relation to the income year or controlling the carrying on of such a business; and

•

the investment management activities carried out in relation to the trust throughout the income year are carried out in Australia.

[Schedule 5, item 4, paragraphs 12-400(1)(a) to (d)]

5.40 Each of these general requirements is considered in detail in paragraphs 5.42 to 5.64.

5.41 Further to these general requirements, there are specific requirements relevant for a MIS that is registered under the Corporations Act 2001 (refer to paragraphs 5.65 to 5.74) and for a trust that is not so registered (refer to paragraphs 5.75 to 5.98) . [Schedule 5, item 4, paragraphs 12-400(1)(e) and (f), and sections 12-401 and 12-402]

The trust must have a relevant connection to Australia

5.42 The first requirement to be met is that the trust must have a relevant connection with Australia. At the time the first fund payment is made (or at an earlier time in the income year), the trustee must be an Australian resident or the central management and control of the trust must be in Australia [Schedule 5, item 4, paragraph 12-400(1)(a)]. This requirement currently applies in item 1 in the table in subsection 12-400(1).

5.43 For the purposes of applying the definition of MIT for the capital account election in Division 275 of the ITAA 1997, if no fund payment is made by the trust, section 275-20 will apply to test whether the trust has a relevant connection with Australia on the first and last days of the relevant income year.

The trust must be a MIS

5.44 The second requirement to be met in order to qualify as a MIT is that, at the time the first fund payment is made, the trust is a MIS, as defined in section 9 of the Corporations Act 2001. [Schedule 5, item 4, paragraph 12-400(1)(d)]

5.45 This is the same condition as currently applies in item 2 in the table in subsection 12-400(1) which, when introduced in 2008, was designed to ensure that the MIT withholding tax rules only applied to trusts subject to an appropriate level of regulation within Australia.

5.46 The requirement that the trust be a MIS is an appropriate and reliable measure of the regulation of the trust itself and is designed to:

•

ensure only a trust associated with the management of investments as regulated by the Corporations Act 2001 can possibly qualify as a MIT;

•

ensure the trust is a genuine collective investment vehicle; and

•

limit the ability of foreign residents to establish a trust for the purposes of accessing the MIT withholding tax rate.

5.47 The MIS requirement acts as a safeguard on the types of trusts that can access the MIT withholding tax rates. For example, where interest holders in a trust have day-to-day control over the operation of the trust, it cannot be a MIS and, therefore, cannot qualify as a MIT for withholding tax purposes. This ensures foreign residents cannot simply establish trusts (that are not regulated by the Corporations Act 2001) to qualify as MITs for the purposes of accessing the MIT withholding tax rates on distributions from the trust.

Example 5.1

ABC trust invests in Australian property. The trust is owned by another trust, interests in which are held by more than 50 foreign individual investors. The foreign investors have the day-to-day control of the operation of the trust and the trust does not qualify as a MIS under section 9 of the Corporations Act 2001. ABC trust cannot qualify as a MIT.

The trust must not be a 'trading trust'

5.48 The third general requirement that must be satisfied in determining whether a trust can qualify as a MIT is that the trust must not be:

•

in the case of a unit trust, a 'trading trust', as defined under Division 6C of Part III of the ITAA 1936. This exclusion is based on the trading trust definition in Division 6C to ensure consistency with the treatment of unit trusts under that Division [Schedule 5, item 4, paragraph 12-400(2)(a)]; and

•

in the case of any other trust, carrying on a trading business or controlling, or being able to control (directly or indirectly) the affairs or operations of another person in respect of the carrying on by that other person of a trading business (within the meaning of Division 6C in Part III of the ITAA 1936) [Schedule 5, item 4, paragraph 12-400(2)(b)].

5.49 A 'trading business' is a business that does not consist wholly of an eligible investment business. An 'eligible investment business' generally means investing in land for rent, or for the primary purpose of deriving rent, or trading and investing in shares, units and financial instruments.

5.50 For a unit trust, the trading trust test; and for other trusts, the test for what is a trading business - both in Division 6C - are appropriate tests to adopt for the purposes of this measure. This is because the MIT withholding tax rules are targeted at passive investments (as are typically undertaken by genuine collective investment vehicles). This can be contrasted with investments that are more akin to the carrying on of an active business operation. Where a trust carries out an active business operation it is more closely aligned with a commercial business than a collective investment vehicle. Such widely held trusts are generally taxed like companies and are not intended to qualify for MIT concessions.

5.51 A requirement that the trust must not be a trading trust ensures that the definition of a MIT is appropriately targeted to attract and retain foreign investment into trusts that are carrying on an eligible investment business, while ensuring they do not put Australian active businesses at a competitive disadvantage. This ensures a level playing field in terms of tax when active business investments are involved and also reduces the erosion of the corporate tax base.

5.52 While the purpose of the MIT withholding tax rules is to encourage foreign investment, the 'trading trust' test appropriately balances the Government's encouragement of foreign investment into the Australian funds management sector and the protection of the integrity of the tax system.

5.53 The new 'trading trust' tests apply in addition to the current rules that ensure a public trading trust cannot qualify as a MIT (see subsection 102T(16) of the ITAA 1936). Under the new rules, public trading trusts will continue to be denied MIT status. The new rules will also deny MIT status to:

•

any unit trust that is a trading trust, including any private trading trust; and

•

any other trust that is carrying on (or has control of) a trading business.

5.54 However, a trust that is a MIT under the current law will continue to be eligible to qualify as a MIT for income years up to and including the 2014-15 income year for MIT withholding tax purposes even though it is a trading trust . [Schedule 5, subitem 6(2)]

Example 5.2

PP Trust is an Australian unit trust that is a registered MIS. PP Trust has been operating since 1 July 2008 and had made a fund payment prior to the introduction of this Bill.

PP Trust owns and operates an infrastructure asset in Australia, and derives its income from the operation of that asset. PP Trust is a trading trust (under section 102N of the ITAA 1936), but is not a public trading trust because it is not a public unit trust. One of PP Trust's members is a complying superannuation fund with more than 50 members. Other members of the trust include both resident and foreign resident investors. Based on these facts, PP Trust, having been in operation since 1 July 2009, is a MIT in respect of the 2009-10 income year.

PP Trust will continue to be able to qualify as a MIT for the 2010-11 through to the 2014-15 income years for the purposes of the MIT withholding tax rules.

5.55 The trading trust exclusion for unit trusts is partially ignored for the purposes of Division 275 [Schedule 5, item 1, section 275-5 of the ITAA 1997]. This is to ensure that despite these trusts being excluded from the definition of a MIT for withholding tax purposes, the trust is eligible to make the choice to have capital account treatment apply. However, the trust will not be eligible for deemed capital account treatment while the trust is a trading trust (within the meaning of Division 6C of the ITAA 1936). This is consistent with the policy objective of Division 6C, which is to tax such trusts like companies.

Example 5.3

Assume the same facts as in Example 5.2, except that PP Trust is established on 1 July 2010. PP Trust is a trading trust for the purpose of Division 6C of Part III of the ITAA 1936. It will not qualify as a MIT for withholding tax purposes but will be eligible to make the choice to have capital account treatment apply. However, while it is a trading trust, the trust will not be eligible for deemed capital account treatment.

The investment management activities in relation to the trust must be carried out in Australia

5.56 The fourth general requirement in order for a trust to qualify as a MIT is that the investment management activities in relation to the trust must be carried out in Australia . [Schedule 5, item 4, paragraph 12-400(1)(c)]

5.57 Since the introduction of the MIT withholding tax rules there is evidence that trusts qualifying as MITs are not necessarily managed by the Australian funds management industry. This can occur where the operator (often the trustee) of the trust outsources the investment management control to a fund manager operating outside Australia.

5.58 Permitting such trusts to qualify as MITs would be inconsistent with the objectives of the MIT withholding tax measure, to increase the level of foreign capital managed by Australian fund managers and support the export of Australian funds management services.

5.59 The requirement that the investment management activities be carried out in Australia does not apply for the purposes of the MIT capital account treatment rules in Division 275 of the ITAA 1997 [Schedule 5, item 1, section 275-10 of the ITAA 1997]. The reason for having the investment management activities rule is to ensure the objectives of the MIT withholding tax rules are met. Those objectives are not identical to the objectives of the MIT capital account measure and therefore this requirement is not extended to that measure.

What are investment management activities?

5.60 At a practical level, the activities involved in operating and managing a fund are quite varied and diverse, and depend on the nature of the underlying investments of the fund. Activities include - but are not limited to - the provision of custodian services, the management and servicing of the underlying assets of the fund (for example, commercial property) and the provision of professional services in relation to various acquisitions, due diligences and disposals of underlying assets.

5.61 These activities can be compared to the investment management activities of a fund - the activities of the fund manager in relation to the investments of the fund. The manager of a MIS is generally appointed to invest and manage the assets of the MIS (the 'portfolio'). The manager must keep the portfolio under review, keep proper books of account in relation to the portfolio and is generally subject to investment instructions (as per the agreement between the manager and operator of the fund) which may set out limitations to the manager's investment discretion.

5.62 Where the manager delegates any of its investment management obligations to another entity, the investment management activities include the activities undertaken in relation to the trust by that other entity. It is these activities that are central to the policy objectives of the MIT withholding tax rules - the policy being that the investment management functions in relation to the fund itself should be carried out in Australia.

5.63 The physical location of investment management activities does not only refer to the place where the final decision to invest (or not) is taken. The fund management activities of the entity must be examined holistically - including market analysis, identification of potential investments and carrying out of due diligence, culminating in the particular investment decision.

5.64 The other activities - such as asset management - that flow from attracting foreign capital to Australia are merely incidental to the fund management activities. It is possible that the asset management activities will occur in Australia in any case regardless of the nature of the investor/purchaser and whether or not such investments are structured through a trust that qualifies as a MIT.

Example 5.4

PT unit trust is an Australian trust that is operated by a trustee (responsible entity) and is a registered MIS. PT unit trust holds commercial property in Australia. It is not a trading trust and has more than 50 members (and so is widely held). Asset management, custodial services, accounting and legal services are provided in Australia, but the fund is managed by SFM Co - a fund manager based in Singapore. SFM Co does preparatory work around market analysis, identifying potential investments and carrying out due diligence on potential investments. This work is undertaken from its office in Singapore.

As SFM Co has no presence in Australia, it is not carrying out the investment management activities in Australia. PT unit trust would not be a MIT (for the withholding tax rules), but would be treated in the same way as a MIT for the purposes of MIT capital account treatment (Division 275 of the ITAA 1997).

Example 5.5

Assume the same facts in Example 5.4, however officers of SFM Co are flown to Australia on two occasions over the course of the income year. While in Australia, these officers make certain investment management decisions as to the purchase of property and carry out final due diligence work associated with that purchase by PT unit trust. SFM Co does not have a physical presence in Australia and has carried out preparatory activities in relation to the investment management in Singapore. Therefore, PT unit trust will not qualify as a MIT for the purposes of the withholding tax rules.

Example 5.6

Assume the same facts in Example 5.4, however, although SFM Co is a fund manager based in Singapore, it has an office through which it operates in Australia. The fund is managed by SFM Co through its office in Australia and all of the investment management activities in relation to PT unit trust are carried out through SFM Co's permanent establishment in Australia. In this case, the requirement that the investment management activities be carried out in Australia is satisfied.

What further specific requirements exist for a trust that is a registered fund ?

5.65 The current law provides that an Australian trust that is a MIS is eligible to qualify as a MIT if, amongst other requirements, it is a MIS operated by a financial services licensee whose licence covers operating such a MIS. The amendments maintain this rule but refer to a trust that is registered under section 601EB of the Corporations Act 2001 [Schedule 5, item 4, paragraph 12-400(1)(e)]. The amendments are intended to have the same effect as the current requirement.

5.66 A trust that is registered will be widely held if it is listed on an approved securities exchange in Australia or has at least 50 members, and is not 'closely held' by a small group (20 or fewer persons) and is not 'closely held' by one foreign resident individual [Schedule 5, item 4, section 12-401]. For the purposes of the small group closely held test, an individual, his or her relatives, and nominees of that individual will be treated as one entity [Schedule 5, item 4, subsection 12-401(2)].

5.67 A trust will be a closely held fund if, at any time in the income year, 20 or fewer persons directly or indirectly:

•

hold, or have the right to acquire, interests representing 75 per cent or more of the value of the interests in the trust;

•

have the control of, or the ability to control, 75 per cent or more of the rights attaching to membership interests in the trust; or

•

have the right to receive 75 per cent or more of any distribution of income that the trust may make.

[Schedule 5, item 4, subparagraph 12-401(1)(b)(i) and section 12-404]

5.68 This percentage in the holding of interest, control of the rights attaching to membership interests, or rights to distribution of income is called the 'MIT participation interest' [Schedule 5, items 3 and 4, subsection 995-1(1) of the ITAA 1997 and section 12-404]. This measurement of interest in the trust is the same as that used in the current law in subsection 12-400(3).

5.69 In addition to the small group closely held test, the trust must also not breach the foreign resident individual closely held test. A trust will breach this test (and, therefore, fail the requirement to be widely held) if, at any time in the income year, one foreign resident individual has a MIT participation interest in the trust of 10 per cent or more . [Schedule 5, item 4, subparagraph 12-401(1)(b)(ii)]

Example 5.7

AF Trust, established in 2008, is a registered MIS with 30 members. One of those members is a foreign limited partnership which has a right to receive 75 per cent of the distribution of income by AF Trust for the 2015-16 income year. As AF Trust is a closely held trust for that income year, AF Trust will not satisfy the widely held requirements and, therefore, will not be a MIT for the 2015-16 income year.

However, if AF Trust made a fund payment in relation to the income year ending 30 June 2009, it would be able to qualify as a MIT (for the purpose of withholding tax) for the income years 2010-11 to 2014-15 (provided in those income years it qualifies as a MIT under the rules prior to the amendments made by this Schedule).

Special rule for start-up and wind-down phases of a trust

5.70 For trusts that are in a start-up phase or a wind-down phase, the widely held requirements will be deemed to be met. However, the wind-down phase rule cannot apply in a year following one in which the start-up phase rule has applied . [Schedule 5, item 4, subsection 12-400(4)]

Includes government-owned MISs

5.71 The amendments allow MISs that are not registered - because they are operated by certain Crown (government-owned) entities and are not required or able to register because of operation of subsection 5A(4) of the Corporations Act 2001 - to be eligible to qualify as a MIT . [Schedule 5, item 4, paragraph 12-400(3)(a)]

5.72 Similar eligibility rules apply to a MIS that is operated by a wholly-owned subsidiary of a Crown entity that would, but for an exemption instrument issued by ASIC under the Corporations Act 2001 that has effect in relation to the entity and operation of the MIS, be required to hold a licence that would cover operating the MIS . [Schedule 5, item 4, paragraph 12-400(3)(b)]

5.73 These rules ensure that government-owned corporations that are bound by all provisions of the Corporations Act 2001 except for Chapters 6A to 6D, 6CA and 7, are treated in the same way as trusts that are operated by a non-government-owned entity.

5.74 Relaxing the Australian Financial Services Licence requirement for state government-owned corporations is consistent with the policy objectives of the MIT withholding tax rules. The amendments ensure that foreign investors in trusts operated by state government-owned corporations can qualify as MITs and be able to access the MIT withholding tax rates. It also ensures a level playing field for trusts operated by state government-owned corporations seeking to attract foreign investment.

What further specific requirements exist for a trust that is an unregistered fund ?

5.75 In addition to satisfying the general requirements to be a MIT (see paragraphs 5.42 to 5.64), a trust that is not registered must also satisfy the following specific requirements:

•

the trust must be a genuine wholesale fund;

•

the trust must be appropriately regulated; and

•

the trust must be widely held.

What funds are genuine wholesale funds ?

5.76 There is no definition of a wholesale fund in the Corporations Act 2001. A trust is determined to be a genuine wholesale fund if, at the time the fund payment is made:

•

it is not required to be registered in accordance with section 601ED of the Corporations Act 2001 because of subsection 601ED(2);

•

the total number of retail clients that are members of the trust is no more than 20; and

•

those retail clients do not have any more than 10 per cent of the interests in, control of, or rights to distribution in, the trust.

[Schedule 5, item 4, subparagraphs 12-400(1)(f)(iii) to (v)]

5.77 Amendments made by this Schedule include a requirement that if the MIS is unregistered, it is because it only provides financial services advice to sophisticated investors (for example, wholesale clients) or only has a small number of retail investors and so is not required to issue a product disclosure statement . [Schedule 5, item 4, subparagraph 12-400(1)(f)(iii)]

5.78 A trust with no more than 20 retail members will be considered a genuine wholesale fund where those retail members hold no more than a 10 per cent interest in the trust [Schedule 5, item 4, subparagraphs 12-400(1)(f)(iv) and (v)]. This de minimis rule ensures the rules defining a MIT are consistent with the Corporate law provisions which allow an unregistered (wholesale) MIS to have up to 20 retail clients.

The trust must be operated or managed by a financial services licensee

5.79 A further requirement that a wholesale fund must meet in order to qualify as a MIT is that it is operated or managed by a financial services licensee, or by an authorised representative of a financial services licensee . [Schedule 5, item 4, paragraph 12-403(1)(a) and subparagraph 12400(1)(f)(ii)]

5.80 Only trusts that are subject to an appropriate level of regulatory oversight should be able to qualify as a MIT. This requirement will be satisfied where an unregistered wholesale trust is either operated or managed by the holder of an Australian Financial Services Licence. The trust may satisfy this requirement in cases where the trustee does not hold an Australian Financial Services Licence but the manager of the fund does - a common scenario in the wholesale fund market. Likewise, a trust may qualify as a MIT where the trustee operator of the fund, but not the manager of the trust, holds an Australian Financial Services Licence . [Schedule 5, item 4, subparagraph 12-403(1)(a)(i)]

5.81 In addition, a trust may qualify as a MIT where the operation or management of the trust is carried out by an authorised representative of the holder of an Australian Financial Services Licence [Schedule 5, item 4, subparagraph 12-403(1)(a)(ii)]. This recognises there may be cases where the operation or management of a trust is delegated by the holder of an Australian Financial Services Licence to another an entity.

Extension to include government-owned MISs

5.82 For similar reasons as provided for registered trusts operated by a government-owned entity, an unregistered government-owned MIS that would otherwise be required to be registered, will be able to qualify as a MIT if the trust is operated or managed by an entity that:

•

would be required under the Corporations Act 2001 to hold a financial services licence but for subsection 5A(4) of that Act (about the Crown not being bound by certain requirements of that Act); or

•

is a wholly-owned subsidiary of such an entity and because of this, the wholly-owned subsidiary is exempt from the requirement to hold a financial services licence because of an instrument issued by ASIC.

[Schedule 5, item 4, paragraphs 12-403(1)(b) and (c) and subsections 12-403(2) and (3)]

5.83 This amendment is targeted at trusts that are operated or managed by government-owned entities and is not intended to cover any broader class of entities for which ASIC may have issued an exemption instrument (which could be for a variety of reasons).

5.84 The reference to subsection 5A(4) of the Corporations Act 2001 is to cover a government-owned corporation. A government-owned corporation is bound by all provisions of the Corporations Act 2001 except for Chapters 6A to 6D, 6CA and 7. Those chapters do not apply to the government-owned corporation under the rules dealing with the application of the Corporations Act 2001 to the Crown in right of the Commonwealth, states and territories etc. Chapter 7 is the chapter dealing with, amongst other things, the requirement to have an Australian Financial Services Licence when operating a financial services business.

When is an unregistered wholesale fund widely held ?

5.85 If a trust is not registered, and it is a genuine wholesale fund (that is, one with predominantly wholesale clients), a different widely held test to the one that applies for retail registered funds must be met.

5.86 A different widely held test is appropriate because, by its nature, a wholesale fund would not be 'widely held'. Therefore, subject to specific closely held tests (see paragraphs 5.96 and 5.97), the widely held test for an unregistered wholesale fund requires the trust have at least 30 wholesale members (which is lower than the 50 member rule that applies for a registered retail fund) . [Schedule 5, item 4, paragraph 12-402(1)(a) and subparagraphs 12-400(1)(f)(i)]

5.87 The 30 member test does not count objects of the trust or individuals (other than individuals that are wholesale clients) as members [Schedule 5, item 4, paragraph 12-402(4)(b)]. It also treats each included individual together with their relatives and nominees as one member [Schedule 5, item 4, paragraph 12-402(6)(a)]. It also treats a member of the trust that is not an individual and nominees of that member as one member [Schedule 5, item 4, paragraph 12-402(6)(b)]. A similar rule also applies for the small group closely held test.

5.88 In determining the number of members of the trust, there is a special rule for counting the members of the trust that are specifically listed widely held entities holding a particular percentage of the value, control of, or rights to, distributions of income from the trust.

5.89 The entities that are covered as specifically listed widely held entities are:

•

a life insurance company;

•

a complying superannuation fund, complying approved deposit fund or foreign superannuation fund, being a fund with at least 50 members;

•

a pooled superannuation trust that has at least one member that is a complying superannuation fund that has at least 50 members;

•

a MIT in relation to the income year; or

•

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

[Schedule 5, item 4, subsection 12-402(3)]

5.90 This list is broadly consistent with the list of entities in the current subsection 12-400(2) and is maintained as it represents entities that are, broadly, widely held funds that are collective investment vehicles.

5.91 The list has been extended to include certain pooled superannuation trusts, where at least one member is a complying superannuation fund with at least 50 members. Including these pooled superannuation trusts in the list of specified widely held entities is consistent with the intention of the MIT withholding tax rules and MIT capital account treatment rules when originally introduced.

5.92 The percentage holding by one of these specifically listed entities is multiplied by 50 (generally the minimum number of members that such an entity must have to qualify as a specifically listed widely held entity) to provide a 'notional member' number of members . [Schedule 5, item 4, paragraph 12-402(2)(c)]

5.93 This notional member number is added to the number of any other members (not counted through the notional member count and only including wholesale clients) to determine the total number of members of a wholesale fund [Schedule 5, item 4, paragraph 12-402(2)(d)]. If this number is at least 30 then, subject to not breaching the specific 'closely held' tests (see paragraphs 5.96 and 5.97), the trust would be treated as widely held.

5.94 In identifying the members of the trust that are entities specifically listed in proposed subsection 12-402(3), a specifically listed entity cannot itself be traced-through when applying the interposed trust rule [Schedule 5, item 4, subsection 12-402(5)]. This avoids any double-counting of indirect members through specifically listed entities.

5.95 The effect of this 'notional member' calculation is that an unregistered wholesale trust can qualify as widely held if it has only one member (for tax purposes) and that member is a specifically listed widely held entity [Schedule 5, item 4, paragraph 12-402(2)(c)]. However, the trust would still need to satisfy the remaining requirements to qualify as a MIT, including that the trust is a MIS except where it is wholly owned by certain special entities (see paragraph 5.115) [Schedule 5, item 4, paragraph 12-400(1)(d)].

Example 5.8

The INS Trust is a wholesale trust that is an Australian resident MIS operated by the holder of an Australian Financial Services Licence in Australia. The members of the INS Trust include a life insurance company and a pooled superannuation trust and four other members, two of whom are wholesale clients. The life insurance company has a 40 per cent interest and the pooled superannuation trust has a 30 per cent interest. The members of the pooled superannuation trust include a complying superannuation fund with 50 members.

The INS Trust will be treated as having the equivalent of 20 members from the life insurance company (50 × 40%), 15 members from the pooled superannuation trust (50 × 30%). The total membership of the INS Trust, for the purposes of the minimum (30) membership rule including the other two (2) wholesale members, is 37.

Specific 'closely held' tests for unregistered wholesale MISs

5.96 Even if the unregistered trust has at least 30 wholesale members, it will not qualify as a MIT if it is closely held under either of the following rules:

•

if, at any time in the income year, 12 or fewer persons have a MIT participation interest in the trust of 75 per cent or more (the small group closely held test); or

•

if, at any time in the income year, one foreign resident individual has a MIT participation interest in the trust of 10 per cent or more (the foreign resident closely held test).

[Schedule 5, item 4, paragraph 12-402(1)(b)]

5.97 The number of persons in the small group closely held test, limited to 12 or fewer for unregistered wholesale funds, is lower than that which applies to registered retail funds (20 persons). This is because overall, a registered retail fund must have at least 50 members, while an unregistered wholesale fund must have at least 30 members (40 per cent lower than the level for retail funds). The member number for the small group closely held rule is likewise set at 40 per cent lower than the total member number required for registered retail funds.

Example 5.9

IMF Trust is an Australian trust that is an unregistered MIS. It has three members. One of its members is PS Trust, a pooled superannuation trust. PS Trust itself has five members, one of which is CSF, a complying superannuation fund with 50 members. The second member of IMF Trust is BSF, a complying superannuation fund with 100 members. PS Trust holds a 40 per cent interest in IMF Trust, BSF holds a 45 per cent interest in IMF Trust and Mr Jones (a foreign resident wholesale client) holds a 15 per cent interest in IMF Trust.

For the purposes of the widely held test in proposed subsection 12-402(2), IMF trust has 46 members (20 from the holding by PS trust (50 × 40%) plus 23 from the holding by BSF (50 × 45%) and one from Mr Jones).

However, as Mr Jones, a foreign resident holds an interest in the trust of more than 10 per cent, IMF Trust will not be able to qualify as a MIT.

A special rule for start-up and wind-down phases of a trust

5.98 For trusts that are in a start-up phase or a wind-down phase, the widely held requirements will be deemed to be met. However, the wind-down phase rule cannot apply in a year following one in which the start-up phase rule has applied . [Schedule 5, item 4, subsection 12-400(4)]

Application and transitional provisions

When will these amendments apply from ?

Application of the amendments for MIT withholding tax purposes

5.99 The amendments made by this Schedule apply to fund payments made in relation to the first income year starting on or after the first 1 July after the day on which the amending Act receives Royal Assent and later income years . [Schedule 5, subitem 6(1)]

5.100 However, if before the day of introduction of this Bill to Parliament, the trustee of a trust makes a fund payment in relation to an income year, the amendments made by this Schedule will not apply to that trust for the 2010-11 to 2014-15 income years . [Schedule 5, subitem 6(2)]

5.101 This 'transitional' application rule is to provide time for investors and managed funds to reorder or restructure their arrangements to comply with the new definition of MIT.

5.102 This 'transitional' rule will only apply in relation to the MIT withholding tax rules and will not apply for the capital account treatment rules in Division 275 . [Schedule 5, subitem 6(3)]

Application of the amendments for MIT capital account treatment rules in Division 275 of the ITAA 1997

5.103 The amendments made by this Schedule apply in relation to Division 275 of the ITAA 1997 in the same way as the amendments made by Schedule 3 to the Tax Laws Amendment (2010 Measures No. 1) Bill 2010 apply in relation to that Division.

5.104 Division 275 of the ITAA 1997 allows eligible Australian MITs to make an irrevocable election to apply the CGT provisions as the primary code for the taxation of gains and losses on disposal of certain assets held as passive investments.

5.105 These rules rely on the section 12-400 definition of a MIT and then treat other trusts (that meet conditions set out in the new Division 275) 'in the same way as a MIT'.

Application of the amended definition of a MIT for the purposes of Subdivision 126-G of the ITAA 1997

5.106 These amendments to the definition of a MIT apply for CGT events happening on or after 1 November 2008, consistent with the application date of the limited roll-over in Subdivision 126-G . [Schedule 5, subitem 6(4)]

5.107 This ensures that the extended MIT definition applies to a 'savings clause' that may allow a MIT to access the limited roll-over for fixed trusts even though the trust has material discretionary elements. This ensures that CGT considerations are not an undue impediment to the restructure of affected MITs.

5.108 This savings clause was intended to apply to trusts that would meet the extended definition of a MIT. However, the decision was undertaken to proceed with the rollover without the extended MIT definition as its development was incomplete at that time.

Consequential amendments

5.109 The trading trust exclusion for unit trusts is partially ignored for the purposes of Division 275 [Schedule 5, item 1, section 275-5 of the ITAA 1997]. This is to ensure that despite these trusts being excluded from the definition of a MIT for withholding tax purposes, the trust is eligible to make the choice to have capital account treatment apply.

5.110 The exclusion only applies to the unit trusts that are trading trusts, as other trusts that carry on (or control) a trading business are not covered by Division 275.

5.111 The requirement that the investment management activities be carried out in Australia does not apply for the purposes of the MIT capital account treatment rules in Division 275 of the ITAA 1997 [Schedule 5, item 1, section 275-10 of the ITAA 1997]. The reason for having the investment management activities rule is to ensure the objectives of the MIT withholding tax rules are met. Those objectives are not identical to the objectives of the MIT capital account measure and this requirement is not extended to that measure.

5.112 The amendments made by this Schedule apply for the purposes of Division 275 of the ITAA 1997. Where a fund payment is not made by a trust, the timing rules in section 12-400 that rely on a fund payment being made will be 'deemed' to have been met on the first and last days of the income year under section 275-20 of the ITAA 1997.

5.113 Section 275-15 of the ITAA 1997 is amended to ensure that an Australian trust will not automatically be treated in the same way as a MIT where every member of the trust is a MIT. This situation is now covered by the look-through rule for unregistered wholesale funds where a member is a MIT . [Schedule 5, item 4, paragraph 12-402(3)(d)]

5.114 Trusts that would have been treated in the same way as a MIT under section 275-15 of the ITAA 1997 now must satisfy a further requirement - that the trust is a MIS and is subject to appropriate regulation . [Schedule 5, item 4, paragraph 12-400(1)(d) and subparagraph 12-400(1)(f)(ii)]

5.115 A trust will be treated in the same way as a MIT where the only member of the trust is one of the Australian specified widely held entities (for example, a life insurance company or a widely held complying superannuation fund) or a foreign superannuation fund with more than 50 members, so long as the trust meets the relevant licensing requirements [Schedule 5, item 2, section 275-15 of the ITAA 1997]. This will ensure that these trusts, which are wholly owned by specified widely held entities and, therefore, may not qualify as a MIS under the Corporations Law, are nevertheless able to qualify as a MIT for the purposes of the MIT capital account election rules.

5.116 A consequential amendment is made to paragraph 45-286(b) as a result of the repeal of subsection 12-400(1) . [Schedule 5, item 5, paragraph 45-286(b)]

Index

Schedule 2: Thin capitalisation

Schedule 3: Exempting certain transactions involving security agencies

Schedule 4: Special disability trusts

Schedule 5: Managed investment trusts