Managed Investment Trust Capital Election

The Tax Laws Amendment (2010 Measures No.1) Bill 2010 is currently before the Senate. This Bill introduces some important changes to the Income Tax Assessment Act 1997 (the 1997 Act) to allow eligible Australian managed investment trusts (MIT) to make an irrevocable election to apply the capital gains tax provisions as the primary code for the taxation of gains and losses on the disposal of certain assets held as passive investments (primarily shares, units and real property).

A MIT will fit the eligibility criteria provided that:

• the trust is an Australian resident
• the trust is a managed investment scheme under the Corporations Act and
• the trust is either listed, widely held or a specified widely held entity and is a member of the trust.

Importantly if an MIT is eligible to make an election and it is not done so, then any gains or losses on the disposal of eligible assets (excluding land, an interest in land or an option to acquire or dispose of such an asset) will be treated on revenue account.

What is an eligible MIT?

A MIT will fit the eligibility criteria provided that:

• the only members of the trust are MITs with at least 50 members
• the trust has at least 50 members
• the members of the trust that are MITs directly or indirectly hold or have the right to acquire interest representing at least 75% of the value of the interest in the trusts or have control of voting or the rights to receive 75% or more of the distributions of income or
• the trust is created or was a MIT in relation to the previous income year and ceases to exist during the income year.

Example

Hyde Trust is a resident Australian trust that is managed by a financial services licensee. Hyde Trust is owned by two wholesale trusts and an individual who is the wholesale client.  Each wholesale trust has 26 non-related individuals respectively. For the purposes of the 50 member test the beneficiaries/unit holders of the wholesale trust will be counted as direct members in the Hyde Trust.  As such the Hyde Trust would have 53 members and it will be treated the same as a MIT.

Key point

Importantly for all wholesale trusts the consequence of the look through is that many trusts that would not have more than 50 members will have more than 50 members when taking into consideration the members/unit holders of any wholesale trust investing in them. This means that there are many Australian resident unit trusts that will actually be eligible under these rules. Importantly where a trust is eligible to make the capital gains tax election if they fail to do so they will have all eligible assets treated on revenue account.  This will greatly impact on funds set up to trade or invest in listed shares but will also have an impact on property trusts (see below).

Eligible assets

The gains or losses that are subject to the capital election only relate to gains and losses in respect of certain assets including:

• shares, shares in a foreign hybrid company and non share equity interest in a company
• units in a unit trust
• land (including interest in land) and
• a right or option to acquire or dispose of one of the assets listed directly above.

However an asset will not be covered by the capital election if it is a financial arrangement to which division 230 of the 1997 Act applies or is a debt interest. Further the deemed revenue treatment for eligible trusts will not apply in respect of land or an interest in land.

Impact for property trusts

Notwithstanding that most property trusts would clearly be on capital account it is still important to consider the application of these rules having the regard to the way in which most property funds are structured. As a property fund would invest in real property either through sub trusts or joint ventures with other parties typically the head investment trust does not actually hold land or an interest in land. The property trust in these circumstances would own units in a sub trust. These units are covered as an eligible asset and any failure to make a capital election under these rules for an eligible MIT would result in any gain or loss on the disposal of the units being on revenue account.

Therefore notwithstanding the carve out of land and interest in land from the deemed revenue treatment it is still necessary for property funds to consider how they are structured and that they make appropriate elections other than the MIT rules.

Action

All managed investment scheme operators should consider whether their various funds meet the extended definition of managed investment trust and whether they need to make an election under the MIT capital election rules.