Edited version of private advice

Authorisation Number: 1051542872447

Date of advice: 25 September 2019

Ruling

Subject: Tax treatment of head trust distributions to non-resident beneficiaries

Question 1

Will Head Trust be considered to be a 'public trading trust' under section 102R of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will distributions from Head Trust to non-resident beneficiaries be in the form of both fund payments (that is, subject to MIT withholding tax under Subdivision 12-H of the Taxation Administration Act (TAA 1953) and distributions subject to tax under subsection 98(2A) and subsection 98(4) of the ITAA 1936?

Answer

Yes.

Question 3

Does Part IVA of the ITAA 1936 apply to the use of Head Trust, Sub Trust A and Sub Trust B as holding vehicles for Australian real estate investments?

Answer

No.

Relevant facts and circumstances

The fund

The fund is established by an Australian independent real estate manager that provides Australian investment opportunities to Australian and international wholesale and institutional investors. The manager holds an Australian Financial Services Licence. It has a disciplined investment strategy, criteria, governance framework and risk parameters.

The fund will comprise two distinct sub-trusts - a passive arm and a trading arm.

The fund will be a 10 year fund with the possibility of extension where approved by investors. Its objective is to invest in or create a portfolio of quality income producing real estate assets. There will be a 3 year investment period from final close. The Fund will be targeting a certain overall internal rate of return ('IRR') or gross equity multiple ('GEM').

The fund will be an unlisted wholesale fund domiciled in Australia and not offered to the public.

Fund investors

Investment in the fund will be sought from the manager's existing investor base and select new investors. The new investors will be privately, specifically and directly approached by the manager as Investment Manager to scope for their interest in participating in the fund.

The expected unitholder composition of Head Trust comprises resident companies (related to the manager), resident complying superannuation funds, resident trusts, non-resident companies, non-resident trusts and non-resident limited partnerships.

The location of non-resident investors is expected to be the various foreign countries. At the time of application, there were no discussions with other potential investors which are not resident in an Exchange of Information (EoI) country. Further, it is anticipated that, other than Australian investors, only non-resident investors resident in EoI countries will invest, directly or indirectly, into Head Trust.

The investors in Head Trust will hold 'units' in the trust which represent a proportionate share, measured by reference to a fixed standard, of the income and property of the trust.

Feeder Fund

Non-resident investors have the option to indirectly invest in the fund through a 'Feeder Fund'. The Feeder Fund will take the form of either a company or a foreign corporate limited partnership incorporated or formed in a foreign jurisdiction that is an EoI country.

Where it is a limited partnership, it will be formed in a foreign jurisdiction, under which, by operation of the applicable law (and not by contract or deed), liability of at least one of the partners is limited.

The voting power of the Feeder Fund will not be controlled by Australian resident shareholders.

The purpose of the Feeder Fund is to eliminate the compliance burden for non-resident investors. As such, it will be an administrative business that undertakes administrative functions including, record keeping, and collecting and distributing funds from/to non-resident investors and returns from Head Trust. It will also manage tax compliance, legal compliance, notifications of distribution notices, pay and receive funds etc. The functions will be outsourced to a local third party service provider in the jurisdiction in which it was formed. The service provider will appoint directors, and perform all functions required to be undertaken by the Feeder Fund.

The high level decisions of the Feeder Fund will be made by the directors of the company (most of whom will not be Australian residents), and such decisions will not be exercised in Australia. To the extent that any directors of the Feeder Fund attend meetings from Australia (e.g. by phone or video conference), a majority of the directors of the Feeder Fund will not be attending from Australia. The directors of the Feeder Fund will not merely rubber stamp or mechanically follow decisions of the directors who will attend meetings from Australia, nor those of the Investment Manager or any other person or body in Australia, but will make decisions in the best interests of the Feeder Fund.

If the Feeder Fund takes the form of a corporate limited partnership, the general partner would generally take part in the management of the business of the partnership, however the general partner will not be an Australian resident and will not undertake any decision making in Australia.

Given that the shareholders of the Feeder Fund will be non-residents, it is unlikely that the shareholders' meetings will be held in Australia. The meetings of directors will mainly occur outside of Australia and the associated documents will be recorded and kept outside of Australia.

Declarations of dividends and payments of dividends will occur outside of Australia. The registered office, the company's books and register of shareholders will be kept outside of Australia.

Fund structure

The fund will comprise a head unit trust (Head Trust), which will hold approximately 99% of the units in Sub Trust A and Sub Trust B unit trusts. The remaining interests (approximately 1%) will be held by a special purpose vehicle ('SPV'), which will be a company for the purposes of this ruling. SPV will hold the units at the Sub Trust A and Sub Trust B level as performance fees will be paid to the manager at the head trust level.

The manager will be the Investment Manager for Head Trust, Sub Trust A and Sub Trust B. It will also be the trustee of Head Trust.

The trustees for Sub Trust A, Sub Trust B and all other sub-trusts will be either a special purpose trustee company or a third party trustee. Sub Trust B will have a different trustee to that of Sub Trust A and each of its sister trusts. There will be 2 directors for each trustee, with only one common director between the trustee for Sub Trust B and the trustee/s for Sub Trust A and each of its sister trusts.

The Investment Memorandum for the Fund will clearly state and differentiate the different strategies of Sub Trust A and Sub Trust B.

There will be no arrangements of any kind between Sub Trust A and Sub Trust B, including no loans, leasing or licensing arrangements between the two entities. Sub Trust A will not rely on, nor influence or impact the financial position of Sub Trust and vice versa.

The funds invested are not intended to be recycled and reinvested, in particular with regard to capital invested in Sub Trust A.

Sub Trust A and its sister trusts

Sub Trust A will hold investments of a 'passive' kind and on a long term basis. It will only conduct the business of investing in commercial, industrial and retail assets for the purpose, or primarily for the purpose, of deriving rent.

Multiple trusts may be established in order to hold the investments through wholly (or partly) owned sub-trusts (i.e. Sub Trust A and its 'sister trusts'). There may be sub-trusts that Sub Trust A owns jointly with third parties not related to the fund.

Specifically, Sub Trust A and its sister trusts will seek to acquire properties with the purpose of continuing to lease them, or improve the rental stream through value creation strategies, including leasing vacant or expiring tenancies, lease repositioning, capital expenditure including refurbishment, asset expansion and/or rehabilitation to maximise rental income over the holding period.

Key to this strategy is the obtaining of favourable prices for the assets, and proactively managing leasing strategies once the assets are acquired.

Prior to the acquisition of any asset, a 'Final Investment Proposal' ('FIP') will be issued by the Investment Manager to the Investment Committee for consideration. The FIP will include:

·        Details of the asset to be acquired;

·        The purpose of the acquisition;

·        What value-add strategies (if any) are to be implemented; and

·        The asset's alignment with the investment strategy of Sub Trust A, including intended holding period, projected rental yields etc.

Accompanying the FIP will be a detailed forecast financial model prepared for each asset proposed to be acquired.

Depending on the time of acquisition of the asset within the Fund's lifecycle, the average expected holding period of the assets will be at least six years, which may expand where an extension of the Fund's life occurs beyond the initial 10 year fund life.

Tax advice and sign-off will also be required to confirm whether an asset is eligible/suitable for Sub Trust A. Where it is unclear, a ruling with the ATO will be sought.

Sub Trust B

Sub Trust B will carry on a trading business.

Prior to the acquisition of any asset, a FIP will be issued by the Investment Manager to the Investment Committee for consideration. The FIP will outline details of the asset to be acquired, the purpose for doing so, the value-add strategies (if any) to be implemented and the asset's alignment with the investment strategy of Sub Trust B.

The assets Sub Trust B will invest in will range from commercial, retail and industrial assets in respect of which the anticipated capital gain component will exceed expected rental income to buying, renting and ultimately selling distressed completed residential housing.

Investment Management Services

The manager will enter into separate Investment Management Agreements with Head Trust, Sub Trust A and Sub Trust B. The activities the Investment Manager will be performing as part of their investment management services will be on an entity-by-entity basis. That is, the activities will reflect, distinguish and clearly delineate between the separate investment strategies (as will be outlined in the Investment Memorandum). The Investment Manager will perform their duty in respect of Sub Trust A (and its sister trusts) separately and independently from its duties to Sub Trust B, and within the parameters set by the Investment Management Agreement with each trust.

Base investment management fees for funds under management or services provided will be paid by Sub Trust A and Sub Trust B respectively.

Subject to the overall performance of the fund, a performance fee will be paid by Head Trust to the manager.

Governance

The fund's compliance with the parameters that will be contained within the Information Memorandum is ensured by way of two committees - the Investment Committee and the Investor Consultation Committee. At least two fully independent members are appointed to the Investment Committee with the other two members of the Investment Committee being members of the manager's Board.

The Investment Committee is responsible for the approval of all significant investment and governance decisions and is independent from the manager's Board. Consistent with industry practice, all acquisition, disposal and other material decisions will require unanimous approval from the Investment Committee.

The Investor Consultation Committee is comprised of investor representatives and is responsible for communicating and consulting with the Investment Committee on any matter referred to them by the Investment Committee. No related party transaction or investment outside the Investment Strategy and criteria may be entered into without first being referred to the Investor Consultation Committee for discussion. In the event that an investment opportunity is outside the Investment Strategy and criteria, specific approval needs to be sought and obtained from the Investment Committee and, ultimately Investors through the Investor Consultation Committee.

The Investment Committee and Investor Consultation Committee (where required) for Sub Trust A (and its sister trusts) and Sub Trust B, will meet and act only in the interests of the respective trusts.

There will be separate agendas, meetings, resolutions and records maintained in respect of each trust.

Neither Sub Trust A nor Sub Trust B will have the ability to appoint members to the Investment Committee. Further, Sub Trust A, the trustee for Sub Trust A, the Investment Manager in its capacity as Investment Manager of Sub Trust A, the Investment Committee and Investor Consultation Committee in their capacities as committees for Sub Trust A, will not have the ability to veto any decisions in respect of Sub Trust B (and vice versa).

Assumption

·        All trusts established as part of the fund will be unit trusts.

·        While there is no certainty as to the investor composition at the date of this ruling, the anticipated investor profile of Head Trust is currently as follows:

˗                  The four resident superannuation funds are complying superannuation funds or a pooled superannuation trust that has at least one member that is a complying superannuation fund, a fund that has at least 50 members.

˗                  The non-resident trust is recognised under a foreign law as being used for collective investment by pooling the contributions of its members as consideration to acquire rights to benefits produced by the entity and has at least 50 members, and the contributing members do not have day-to-day control over the entity's operation.

˗                  At least 95% of the membership interests in the limited partnership are owned by entities mentioned in subsection 275-20(4)(a)-(ia), or by entities that are wholly-owned by those entities; and the remaining membership interests (if any) in the limited partnership are owned by a general partner of the limited partnership that habitually exercises the management power of the limited partnership.

·        The trustees for all unit trusts in the Head Trust chain of trusts are Australian resident entities for income tax purposes.

·        The Investment Manager is an Australian resident entity and conducts all its investment management activities in relation to the fund in Australia.

·        While the Investment Manager operates or manages Sub Trust A, it will be a financial services licensee (within the meaning of section 761A of the Corporations Act 2001) that holds an Australian financial services licence, which licence covers it providing financial services (within the meaning of section 766A of that Act) to wholesale clients (within the meaning of section 761G of that Act).

·        Sub Trust A and each of its sub-trusts will be a managed investment scheme ('MIS') under section 9 of the Corporations Act 2001.

·        Sub Trust A is an unregistered wholesale trust and is not required to be registered in accordance with section 601ED of the Corporations Act 2001 because of subsection 601ED(2) of that Act.

·        Head Trust and SPV had not become members of Sub Trust A because a financial service was provided to, or acquired by, the members as a retail client (within the meaning of sections 761G and 761GA of the Corporations Act 2001).

·        Sub Trust A will carry on a business that consists wholly of eligible investment business.

·        Sub Trust A and Sub Trust B will only invest in real estate situated in Australia and will only derive Australian sourced income.

·        Head Trust is not eligible to elect into the Attribution MIT ('AMIT') regime.

·        Subtrust B is neither a public unit trust that would attract the operation of Division 6C of the ITAA 1936, nor a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953.

·        Subtrust A is a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953.

Reasons for decision

Question 1

Will Head Trust be considered to be a 'public trading trust' under section 102R of the ITAA 1936?

Summary

No.

Detailed reasoning

Section 102R in Division 6C of the ITAA 1936 sets out the test for a unit trust to be a 'public trading trust':

102R(1) A unit trust is a public trading trust in relation to a relevant year of income if:

...(b) where the relevant year of income is the year of income commencing on 1 July 1988 or a subsequent year of income:

(i) the unit trust is a public unit trust in relation to the relevant year of income;

(ii) the unit trust is s public trading trust in relation to the relevant year of income;

(iii) either of the following conditions is satisfied:

(A) the unit trust is a resident unit trust in relation to the relevant year of income;

(B) the unit trust was a public trading trust in relation to a year of income preceding the relevant year of income.

Accordingly, one of the key requirements for a unit trust to be a 'public trading trust' in relation to the relevant income year is that it must, among other things, be a 'public unit trust'. The phrase 'public unit trust' is defined in section 102P relevantly as follows:

102P(1) For the purposes of this Division, but subject to the succeeding provisions of this section, a unit trust is a public unit trust in relation to a year of income if, at any time during the year of income:

(a) any of the units in the unit trust were listed for quotation in the official list of a stock exchange in Australia or elsewhere;

(b) any of the units in the unit trust were offered to the public; or

(c) the units in the unit trust were held by not fewer than 50 persons...

102P(4) Subject to subsection (5), a unit trust that, but for this subsection and subsection (7), would be a public unit trust in relation to a year of income by virtue only of subsection (1) shall be deemed not to be a public unit trust in relation to the year of income if, at any time during the year of income, one person or persons not more than 20 in number held, or had the right to acquire or become the holder or holders of, a unit or units in the unit trust that entitled the holder or holders thereof to not less than 75% of:

(a) the beneficial interests in the income of the unit trust; or

(b) the beneficial interests in the property of the unit trust...

102P(10) For the purposes of this section, where any units in a unit trust (except a foreign entity to which subsection 102N(2) applies) are held by the trustee of another trust estate, a person who has a beneficial interest in property of that other trust estate that consists of those units (whether or not that beneficial interest is deemed to be held by virtue of the application of this subsection) shall be deemed to hold those units.

102P(10A) Subsection (1) does not apply in relation to units in a unit trust that are held by the trustee of another trust estate if the other trust estate is a complying superannuation entity (within the meaning of the Income Tax Assessment Act 1997)...

For the purposes of section 102P, if a trustee of another trust estate holds units in a unit trust, subsection 102P(1) deems the person/s who have a beneficial interest in that other trust estate that consists of those units as being the holder.

In the present case, the direct unitholders in Head Trust are expected to include 1 non-resident trust. It is unknown at this stage how many persons will have a beneficial interest in that non-resident trust.

However, even if the number of persons who hold beneficial interests in the non-resident trust is sufficient to satisfy the requirement in paragraph 102P(1)(c), subsection 102P(4) would apply in this case to deem Head Trust not to be a public unit trust in relation to the relevant year of income. Subsection 102P(4) applies if no more than 20 persons held, or had the right to acquire or become the holder or holders, of a unit or units in the unit trust that entitled them to 75% or more of the beneficial interests in the income or property of the unit trust.

Based on the anticipated investor profile of Head Trust and their respective proportionate ownership, 95% of units in Head Trust will be held by 11 persons (the 2 resident companies, 4 resident superannuation funds, 1 non-resident company and 3 non-resident limited partnerships. Therefore, even if Head Trust falls within the paragraph 102P(1)(c) requirement, subsection 102P(4) will apply to deem it not to be a public unit trust because 75% or more of the beneficial interests in the income or property of the trust is held by no more than 20 persons.

Question 2

Will distributions from Head Trust to non-resident beneficiaries be in the form of both fund payments (that is, subject to MIT withholding tax under Subdivision 12-H of the TAA 1953) and distributions subject to tax under subsection 98(2A) and subsection 98(4) of the ITAA 1936?

Summary

Yes.

Detailed reasoning

Division 6 of the ITAA 1936 sets out the basic income tax treatment of the net income of a trust estate, subject to the modifications contained in Division 6E of the ITAA 1936 (where relevant), with Subdivision 115-C providing the corresponding taxation treatment for that part of the net income of the trust estate that comprises capital gains.[1] Division 6 also contains specific provisions that facilitate the collection of the tax payable by a non-resident beneficiary of a trust estate who is presently entitled and liable to pay tax in respect of their share of the net income of the trust estate.

However, where the whole, or part, of the net income of a trust estate represents or is reasonably attributable to fund payments made by a MIT to certain recipients, that part may be carved out of the operation of Division 6 and be subject to the withholding rules in Subdivision 12-H in Schedule 1 to the TAA 1953.

As Head Trust is not a 'public trading trust' for the purposes of Division 6C of the ITAA 1936, the rules in Division 6, as modified by Division 6E (where relevant), will generally apply to the net income of the trust estate. Subdivision 12-H, rather than Division 6, may apply in relation to that part of Head Trust's net income that is attributable to fund payments that have been subject to MIT withholding.

The net income of Head Trust will comprise distributions from Sub Trust A and Sub Trust B in the form of Australian sourced income which includes rent, interest income and capital or revenue gains.

Sub Trust B distributions

Sub Trust B is neither a public unit trust that would attract the operation of Division 6C of the ITAA 1936, nor a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953. Therefore, the distributions that Head Trust receives from Sub Trust B, and which it subsequently distributes to Head Trust investors, will be subject to the general rules in Division 6 of the ITAA 1936, as modified by Division 6E of the ITAA 1936 (where relevant). Note also the application of Subdivision 115-C of the ITAA 1997 where the net income of a trust estate includes a net capital gain.

The general position is that, except as provided in the income tax Act, a trustee shall not be liable as trustee to pay income tax upon the income of the trust estate pursuant to section 96 in Division 6 of the ITAA 1936.

The provisions in the income tax Act that makes a trustee liable to pay income tax upon the income of the trust estate are, relevantly, sections 98 and 99[2]. Section 99 applies where, among other things, no part of the net income of a resident trust estate is assessable to the trustee in pursuance of section 98. For present purposes, the focus is on section 98. Of particular relevance are subsections 98(2A) and 98(3) (where a beneficiary is not a trustee) and 98(4) (where a beneficiary is a trustee themselves), which operates to assess the trustee on behalf of certain beneficiaries who, among other things, were non-residents at the end of the income year and who were presently entitled to income of the trust estate, to the extent the income is attributable to sources in Australia. These provisions are reproduced below:

98(2A) [Non-resident beneficiary]

If:

(a) a beneficiary of a trust estate who is presently entitled to a share of the income of the trust estate:

(i) is a non-resident at the end of the year of income; and

(ii) is not, in respect of that share of the income of the trust estate, a beneficiary in the capacity of a trustee of another trust estate; and

(iii) is not a beneficiary to whom section 97A applies in relation to the year of income; and

(iv) is not a beneficiary to whom subsection 97(3) applies; and

(b) the trustee of the trust estate is not assessed and is not liable to pay tax under subsection (1) or (2) in respect of any part of that share of the net income of the trust estate;

subsection (3) applies to the trustee in respect of:

(c) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was a resident; and

(d) so much of that share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia.

98(3) [Liability to tax]

A trustee to whom this subsection applies in respect of an amount of net income is to be assessed and is liable to pay tax:

(a) if the beneficiary is not a company - in respect of the amount of net income as if it were the income of an individual and were not subject to any deduction; or

(b) if the beneficiary is a company - in respect of the amount of net income at the rate declared by the Parliament for the purposes of this paragraph.

Note: If the trust estate's net income includes a net capital gain, and the beneficiary is a company, Subdivision 115-C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.

98(4) [Non-resident beneficiary a trustee of another trust]

If:

(a) a beneficiary of a trust estate (the first trust estate) who is presently entitled to a share of the income of the first trust estate:

(i) is, in respect of that share of the income of the first trust estate, a beneficiary in the capacity of a trustee of another trust estate; and

(ii) is not a beneficiary to whom subsection 97(3) applies; and

(b) a trustee of the other trust estate is a non-resident at the end of the year of income;

the trustee of the first trust estate is to be assessed and is liable to pay tax in respect of so much of that share of the net income of the first trust estate as is attributable to sources in Australia at the rate declared by the Parliament for the purposes of this subsection.

Note: If the trust estate's net income includes a net capital gain, Subdivision 115-C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.

Accordingly, when Head Trust receives a distribution of income from Sub Trust B and distributes the income to Head Trust non-resident beneficiaries, the trustee for Head Trust will be liable to pay income tax on the income forming part of the income of the trust estate if subsection 98(2A) or 98(4) applies.

Where a presently entitled Head Trust non-resident beneficiary is not another trust estate, subsection 98(2A) will apply. The trustee for Head Trust will be liable to pay income tax on so much of the share of the net income of the trust estate as is attributable to a period when the beneficiary was not a resident and is also attributable to sources in Australia. Where the non-resident beneficiary is a company, the trustee of Head Trust will be assessed and liable to pay tax in respect of the relevant amount of net income at the corporate tax rate (paragraph 98(3)(b)). If the non-resident beneficiary is not a company, the trustee of Head Trust will be assessed and liable to pay tax in respect of the relevant amount of net income as if it were the income of an individual and were not subject to any deduction (paragraph 98(3)(a)).

Where a presently entitled Head Trust non-resident beneficiary is another trust estate, subsection 98(4) will apply. The trustee of Head Trust will be assessed and liable to pay tax in respect of so much of the relevant share of the net income of Head Trust as is attributable to sources in Australia, and at the rate declared by the Parliament for the purposes of subsection 98(4).

Where the net income of a trust estate includes a capital gain, Subdivision 115-C operates simultaneously with Division 6, such that the taxation of a trust's capital gains is dealt with under the former and effectively taken out of the latter.

Note that the tax assessed to a trustee in relation to a non-resident beneficiary under subsections 98(2A), 98(3) and 98(4) is generally not a final tax. Non-resident beneficiaries must still include in their assessable income the relevant individual interest in the net income of the trust estate, and an appropriate amount of income tax will be deducted against the beneficiary in respect of the tax paid by the trustee under section 98A of the ITAA 1936.

Sub Trust A fund payments

As Sub Trust A is a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953, the fund payments it makes to Head Trust, and upon which Head Trust makes its beneficiaries presently entitled to, may be subject to the withholding rules in Subdivision 12-H.

Section 12-375 in Subdivision 12-H of the TAA 1953 sets out what the Subdivision is about:

A withholding MIT may be required to withhold an amount from a payment of its Australian sourced net income (other than dividends, interest and royalties) if the payment is made to an entity whose address, or place for payment, is outside Australia. If the payment is made to another entity, the withholding MIT is required to make information available to the recipient outlining certain details in relation to the payment...

If an entity that is not a custodian receives a payment that is covered by that information, it is required to withhold an amount from that payment if a foreign resident becomes entitled to that payment. If a resident becomes entitled to the payment, the entity must make information available in relation to that payment.

Where there is an obligation to withhold, the applicable withholding rate is determined by the nature of the country or territory in which the recipient's address, place for payment or residency is located and whether the trust is a clean building managed investment trust...

Where an entity that is not a custodian receives a payment from a withholding MIT of the MIT's Australian sourced net income (other than dividends, interest and royalties) and proceeds to make a payment to its beneficiaries, subsection 12-390(4) is triggered. The provision is reproduced below:

Withholding by other entities

12-390(4) An entity that is not a *withholding MIT or a *custodian must withhold an amount from a payment it receives if:

(a) the payment or part of it (the covered part) was covered by a notice or information under section 12-395; and

(b) a foreign resident (the recipient) is or becomes entitled:

(i) to receive from the entity; or

(ii) to have the entity credit to the recipient, or otherwise deal with on the recipient's behalf or as the recipient directs;

an amount (the attributable amount) reasonably attributable to the covered part.

Note 1: The covered part referred to in paragraph (4)(a) is attributable to a fund payment made by a managed investment trust, or 2 or more fund payments made by one or more managed investment trusts. One or more of those managed investment trusts may be AMITs.

Note 2: If the recipient is not a foreign resident, the entity is required to give a notice to the recipient or public information on a website setting out certain details about the payment: see section 12-395.

12-390(5) The amount the entity must withhold is:

Attributable amount x Rate applicable under subsection (6)

12-390(6) The rate is:

(a) if the recipient is a resident of an *information exchange country:

(i) 22.5% for *fund payments...in relation to the first income year starting on or after the first 1 July after the day on which the Tax Laws Amendment (Election Commitments No. 1) Act 2006 receives the Royal Assent; or

(ii) 15% for fund payments...in relation to the following income year; or

(iii) 7.5% for fund payments...in relation to later income years starting before 1 July 2012; or

(iv) 15% for fund payments...in relation to later income years starting on or after 1 July 2012; ...

(b) otherwise - 30%...

Section 12-390(7) clarifies which entities are residents of an information exchange country:

12-390(7) An entity is a resident of an *information exchange country if:

(a) the entity is a resident of that country for the purposes of the taxation laws of that country; or

(b) if there are no taxation laws of that country applicable to the entity or the entity's residency status cannot be determined under those laws:

(i) for an individual - the individual is ordinarily resident in that country; or

(ii) for another entity - the entity is incorporated or formed in that country and is carrying on a business in that country.

For completeness, section 12-390 does not apply to an amount paid or received by an entity to the extent that no MIT withholding tax is payable in respect of the amount or an amount reasonably attributable to the amount.[3] As a consequence, no MIT withholding tax is payable in respect of an amount paid by Head Trust that is reasonably attributable to a distribution from Sub Trust B.

Where Head Trust makes a non-resident beneficiary entitled to an amount reasonably attributable to the payment, or part of the payment, that is covered by the notice or information, Head Trust must withhold an amount (subsection 12-390(4)). Depending on the residency of the non-resident beneficiaries of Head Trust, the withholding rate will be either 15% (EoI country) or 30% (non-EoI country).

Whereas Subdivision 12-H sets out the rules concerning collection by mainly Australian resident entities, Subdivision 840-M of the ITAA 1997 imposes the liability to pay the MIT withholding tax on certain non-resident beneficiaries. The relevant provisions are reproduced below:

Section 840-800 What this Subdivision is about

If you are a foreign resident you may be liable to pay income tax on certain amounts of Australian sourced net income (other than dividends, interest and royalties) of a withholding MIT that are either paid to you or to which you become entitled.

A beneficiary (other than a foreign pension fund) of a trust in the capacity of a trustee of another trust will not be liable to income tax on these amounts.

Amounts on which there is a liability to pay withholding tax are non-assessable non-exempt income...

Liability

840-805(1) You are liable to pay income tax at the rate declared by the Parliament on the amount identified in subsection (2), (3) or (4) as the fund payment part if that subsection applies to you.

Note 1: The tax, which is called managed investment trust withholding tax, is imposed by the Income Tax (Managed Investment Trust Withholding Tax) Act 2008 and the rate of the tax is set out in that Act.

Note 2: See Subdivision 12-H in Schedule 1 to the Taxation Administration Act 1953 for provisions dealing with withholding from fund payments...

Entitlement to amounts from other entities

840-805(4) This subsection applies to you if:

(a) you are a beneficiary of a trust (that is not a *withholding MIT or a *custodian) and are presently entitled to a share of the income or capital of the trust; and

(b) all or part of that share (also the fund payment part) is reasonably attributable to a payment that is a *fund payment in relation to an income year made by a trust that is a withholding MIT in relation to that year; and

(c) you are not, in respect of that share, a beneficiary in the capacity of a trustee of another trust; and

(d) you are a foreign resident at the time (the entitlement time) when you became presently entitled.

Consistent with section 840-800 and, relevantly, paragraph 840-805(4)(c), Subdivision 840-M imposes a liability to pay MIT withholding tax on non-resident entities that are not in the capacity of a trustee of another trust. An explanation of this requirement is provided in the Explanatory Memorandum to the Income Tax (Managed Investment Trust Withholding Tax) Bill 2008 ('the EM to the 2008 Bill'):

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

With this in mind, section 840-815, which states that amounts on which MIT withholding tax is payable is NANE income, can be construed to apply to situations involving interposed trusts where the ultimate non-resident beneficiary is liable to pay MIT withholding tax:

840-815(1) An amount on which *managed investment trust withholding tax is payable is not assessable income and is not *exempt income of an entity.

The effect of subsection 840-815(1) on the operation of the other provisions in the income tax Acts is explained in the EM to the 2008 Bill:

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

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

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

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

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

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

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

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

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

Consistent with the above extract, to the extent that the net income of Head Trust is reasonably attributable to a fund payment that is subject to withholding under Subdivision 12-H (i.e. fund payments from Sub Trust A), such amount will be not assessable and not exempt, not only in the hands of Head Trust's non-resident beneficiaries (whether they themselves are a trustee of another trust estate), but also in the hands of any other entity, including Head Trust, that would otherwise have been subject to tax in respect of that income under any other provision of the income tax Act, including Division 6 of the ITAA 1936.
>

Question 3

Does Part IVA of the ITAA 1936 apply to the use of Head Trust, Sub Trust A and Sub Trust B as holding vehicles for Australian real estate investments?

Summary

No.

Detailed reasoning

Section 177D requires there to be a person/s who entered into or carried out the scheme or any part of the scheme to have done so for the purpose of enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme. It is that tax benefit that would then be cancelled if a determination is made under subsection 177F(1). Section 177D(1) relevantly provides:

Section 177D Schemes to which this Part applies

Scheme for purpose of obtaining a tax benefit

177D(1) This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of:

(a) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.

Broadly, the three key requirements of subsection 177D(1) are:

·        a 'scheme', which is given wide definition in subsection 177A(1);

·        a 'tax benefit in connection with the scheme', as defined in section 177C together with section 177CB; and

·        the requisite purpose, the subject matter of section 177D.

In determining whether the requirements of subsection 177D(1) have been satisfied in a particular case, regard must be had to the eight matters specified in subsection 177D(2).

The remaining subsections 177D(4) and (5) simply require the scheme to have been entered into, carried out or commenced to be carried out after 27 May 1981, and clarifies that section 177D applies whether or not any part of the scheme has been or is entered into or carried out in Australia or outside Australia.

The scheme

Subsection 177A(1) defines 'scheme' broadly as follows:

scheme means:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

As highlighted in PS LA 2005/24, Part IVA was intended to be construed as a whole. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Relevantly, a scheme can comprise 'a series of interrelated acts by a person or persons over a period of time',[4] or, within a wider scheme there could also be an alternative narrower scheme that meets the requirement of Part IVA.[5]

The scheme is as described in the Relevant facts and circumstances. However, for the purposes of this question 3, the scheme excludes the establishment of the Feeder Fund and therefore, all non-resident investors will be investing directly in Head Trust.

Tax benefit

The reference in section 177D to the obtaining by a taxpayer of a tax benefit in connection with a scheme is defined in section 177C. Relevantly, section 177C states:

Section 177C Tax benefits

(1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; ...

and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:

(c) in a case to which paragraph (a) applies - the amount referred to in that paragraph;...

For schemes entered into on or after 16 November 2012, section 177CB also applies in determining the tax benefit. Section 177CB relevantly states:

Section 177CB The bases for identifying tax benefits

...(2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme).

(3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.

(4) In determining for the purposes of subsection (3) whether a postulate is such a reasonable alternative:

(a) have particular regard to:

(i) the substance of the scheme; and

(ii) any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of this Act); but

(b) disregard any result in relation to the operation of this Act that would be achieved by the postulate for any person (whether or not a party to the scheme).

Several alternative postulates were identified in the application. These are considered below:

    Alternative postulate 1: Settle Head Trust as a single trust at the top with a number of sub-trusts that will hold all the assets, regardless of whether they qualify as EIB or not.

In terms of the income tax consequences, alternative postulate 1 will result in Head Trust not satisfying the requirements to be a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953.

This will mainly impact non-resident investors in Head Trust as they will no longer be eligible for the final MIT withholding tax at a rate of 15% in respect of EIB, but instead, will have to include in their assessable income their individual shares of the net income of the Head Trust (both EIB and non-EIB components) in accordance with Division 6 of the ITAA 1936, as modified by Division 6E of the ITAA 1936 (other than interest, which is subject to final withholding tax). On the basis of the income tax consequences that would arise under the alternative postulate, it is arguable that a prima facie 'tax benefit' arises under paragraphs 177C(1)(a) and (c) in the current scheme, being the non-inclusion of such amounts in their assessable income under the present scheme, (under which they will instead be deemed to be NANE income). However, a tax benefit will only be said to arise if the alternative postulate considered is what would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into.

In this regard, the Commissioner has accepted the taxpayer's submissions that this alternative postulate is not a commercially realistic one, for the reason that non-resident investors are not likely to invest in a non-MIT structure where a significant portion of the underlying investments are held for the long term to derive rent. That is, the postulate does not achieve the wider commercial and practical outcomes sought to be achieved under the scheme. It is also noted in particular that the MIT regime was introduced 'to enhance the competitiveness of the Australian funds management industry' and 'to secure Australia's position as a financial services centre'[6], where a significant portion of the underlying investments are EIB. In the circumstances of the present case, it would be reasonable to expect such investments to be held via a MIT structure in order to attract foreign investment.

Therefore, alternative postulate 1 does not result in a tax benefit in connection with the scheme within the meaning of subsection 177C(1).

    Alternative postulate 2: Settle 2 trusts at the top, namely Sub Trust A and Sub Trust B, and staple the units. Sub Trust A and its sub-trusts will hold only EIB assets. Sub Trust B and its sub-trusts will hold non-EIB assets. Sub Trust A and Sub Trust B will have different trustees, with a different composition of board of directors for each corporate trustee. The affairs and operations of Sub Trust A will be controlled independently and will be separate from Sub Trust B. Resident and non-resident investors will then subscribe for stapled units in the trusts.

The income tax consequences of alternative postulate 2 is that Sub Trust A will likely satisfy the requirements to be a withholding MIT for the purposes of Subdivision 12-H in Schedule 1 to the TAA 1953. Whereas, Sub Trust B will not be a MIT and distributions of its income to investors will be subject to the general provisions in Division 6 of the ITAA 1936, as modified by Division 6E of the ITAA 1936.

In comparing the income tax consequences of alternative postulate 2 with that of the scheme, there is no difference. This is because even though under the scheme, Head Trust was interposed between Sub Trust A and Sub Trust B and the investors, withholding MIT treatment was retained in relation to fund payments from Sub Trust A and Division 6 applied in relation to distributions from Sub Trust B.

Therefore, alternative postulate 2 does not produce a tax benefit in connection with the scheme within the meaning of subsection 177C(1).

    Alternative postulate 3: Incorporate an Australian resident company to hold all the units in Sub Trust A and Sub Trust B and their sub-trusts.Again, the trustees will be different for each of Sub Trust A and Sub Trust B, with the composition of the board of directors also being different for each corporate trustee. The affairs and operations of Sub Trust A will be controlled independently and will be separate from Sub Trust B and the holding company. Resident and non-resident shareholders will then subscribe for shares in the company.

As discussed in relation to alternative postulate 1, the attraction of foreign investors forms a significant part of the broader commercial purpose of the arrangement; and the MIT regime was introduced 'to enhance the competitiveness of the Australian funds management industry' and 'to secure Australia's position as a financial services centre'[7], and therefore, where a significant portion of the underlying investments are EIB, it would be reasonable to expect such investments to be held via a MIT structure in order to attract foreign investment.

As the identification of a tax benefit is essential for the application of section 177D, in failing this requirement it is not necessary to consider the dominant purpose requirement. Therefore, Part IVA will not apply to the scheme.

[1] Note that Subdivision 207-B of the ITAA 1997 is not relevant for present purposes as the net income of Head Trust will not include franked distributions and franking credits.

[2] Section 99 applies where there is a part of the net income of a resident trust estate that has not been subject to the application of section 97 or section 98, or that represents income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia.

[3] Subsection 12-390(10)

[4] Corporate Initiatives Pty Ltd v CoT [2005] FCAFC 62, as extracted in PS LA 2005/24, at [57].

[5] FCT v Peabody (1994) 181 CLR 359 as extracted in PS LA 2005/24, at [58].

[6] Paragraphs 5.11 and 5.14 in the EM to the Tax Laws Amendment (2010 Measures No. 3) Bill 2010

[7] Paragraphs 5.11 and 5.14 in the EM to the Tax Laws Amendment (2010 Measures No. 3) Bill 2010