ATO reviews into Attribution Managed Investment Trusts (AMITs) on the horizon – review your fund’s position now!
The ATO recently announced, at this year’s Financial Services Tax Conference, that it would be commencing MIT and AMIT reviews in Q3. Given the current situation on COVID-19, it might be the case that these reviews will be deferred until Q4 or even into next financial year.
However, any delay by the ATO raises the risk that another tax year is completed and, if incorrect positions on AMIT have been taken for a completed year, it is all the more unlikely that incorrect positions may be able to be unwound.
Any trustee or Responsible Entity (RE) that has elected for a fund to enter the AMIT regime should ensure that the fund satisfies the eligibility conditions for being an AMIT or otherwise expose themselves and/or their investors to unfavourable tax outcomes.
AMIT - benefits and eligibility
While the MIT regime has been around for over 10 years, the AMIT regime has only been in existence for a few years.
One of the key benefits of the MIT regime is that it provides ‘capital account’ treatment for gains made by qualifying funds on the disposal of shares and land interests. In order to qualify as a MIT, the fund must meet certain conditions (e.g. Australian residency, widely held requirements, AFSL requirements).
MITs that also have ‘clearly defined rights’ for their investors, can qualify for the AMIT regime. Broadly speaking, the benefits of the AMIT regime include:
- deemed fixed trust treatment (so franking credits can pass to investors and tax losses can be carried forward in the trust and deducted in later years); and
- the only means by which a trustee can operate an ‘unders’ and ‘overs’ regime to account for differences between cash and tax distributions to investors.
Neither the MIT nor the AMIT regime is automatic and needs to be elected into, but only once the pre-conditions for eligibility are met.
Most of the pre-conditions should be able to be met for funds with an Australian trustee or a RE that invests in assets through a local fund manager. The conditions for eligibility that pose the most risk for trustees/REs are the requirements that:
- The fund is ‘widely held’. This requires a minimum ‘spread’ of investors. For instance, wholesale funds require at least 25 investors. Funds with certain types of institutional or pooled investment members receive some concessions in calculating the total number of members; and
- The fund cannot be ‘closely held’. In broad terms, the fund’s membership cannot be too tightly held. For instance, 10 or fewer investors in a wholesale fund cannot hold 75% or more of the interests in the fund.
Compliance with most of the conditions is easy to identify. However, many funds will have to actively perform some form of analysis to confirm that they meet the widely held and not closely held tests. These tests need to be assessed annually. It is known that some fund managers and trustees are concerned that a recent increase in requests for redemption may jeopardise the fund’s ability to be considered widely-held.
One of the interesting aspects of the AMIT regime is that a ‘start-up’ phase is permitted for new funds in order to meet the widely held and not closely held tests. In broad terms, trustees/REs have until the end of the fund’s first two completed years to meet those tests.
It may well be that a trustee/RE has assumed that these tests have been satisfied without any formal analysis, or performed it in the early life of the fund only to discover that they did not meet the tests but have not followed-up whether the conditions were met later in the start-up phase.
Problematically, the two year start-up phase has ended (or is about to end) for many newly created funds whose trustees or REs elected for their funds to enter the regime on or before 1 July 2018.
What if the fund doesn’t qualify as an AMIT (and you thought it did qualify)?
So, what happens if a trustee or RE has elected into AMIT but the conditions for eligibility have not been met?
If your fund has failed to meet the conditions for eligibility to go into AMIT, but your fund’s system reports on an AMIT basis, here are some of the key tax risks you will face:
- If you believed your fund operates as a ‘fixed’ trust for tax purposes - so as to pass franking credits to your investors or for deducting prior year losses - the fund no longer gets automatic fixed trust treatment. It may be that your fund can still be a fixed trust, but you will need to perform an analysis to determine whether your fund is, in actual fact, a fixed trust, or can meet the ATO’s safe harbour in PCG 2016/6. If a fund is not a fixed trust, it will not be possible for franking credits to pass to investors and investors will likely have underpaid tax on their dividend distributions.
- If you’ve adjusted for unders and overs in the year of detecting the error, typically in the year after the relevant year when you should have returned the relevant income or (not) claimed the relevant deduction - you cannot rely on that AMIT concession to adjust for unders and overs in the year of detection.
Outside of the AMIT regime, the ATO will require all unders and overs to be adjusted in the actual year to which the relevant income/deduction relates. This may mean the administratively burdensome task of seeking amended assessments for the fund (and having to explain these outcomes to investors). Challenges with this approach will arise if investors have redeemed their units or invested into the fund after the relevant year. Depending on how the fund’s constitution is worded and/or how the trustee operates the fund’s year end processes, it may be that the trustee may end up with a tax liability if the fund doesn’t qualify as an AMIT.
- If you’ve attributed more assessable income to a member than has actually been distributed to them, such that the member’s unit cost base is adjusted upwards - that member will not have been entitled to the upward adjustment. If the member had disposed of their units following an upward adjustment to which they were not entitled, they may have a greater capital gain (or a lower capital loss).
This issue may become prevalent in the current environment when income of the fund has been attributed to investors, but the trustee/RE has chosen to not fully pay a comparable cash distribution in order to preserve cash, reinvest it or to fund redemptions.
What if the fund doesn’t qualify as a MIT (and you thought it did qualify)?
Similarly, in the case of the MIT regime, it may be that the trustee assumed that the capital account election was able to be made. If the fund did not meet the requirements to be a MIT at the time when the election was made, gains made by the fund may have been erroneously treated as capital gains by default.
If the election was not strictly available, the gains may still be on capital account - and so investors may still be able to take advantage of the 50% CGT discount. However, the analysis may be somewhat problematic under the ‘normal’ revenue/capital principles where there is - notoriously - no ‘line in the sand’ or safe harbour. In these cases, investors may have only paid tax on half of the gains made by the fund when the full gain should have been subject to tax.
Increased ATO review activity
Trustees' and responsible entities have, so far, had the benefit of a benevolent ATO in the transitional phase of the MIT/AMIT regime. Going forward, they can, and should, expect a greater level of scrutiny over the disclosures in the fund’s annual tax return that may result in a questionnaire or review of the position taken. The reviews may well highlight tax risks, with adverse outcomes - and additional tax burdens - on either or both of the trustee or responsible entity, and investors.
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