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Australian managed investment trusts (MITs) (as defined for tax purposes) are eligible for the following important tax concessions:

1. MIT withholding: that is, a concessional rate of withholding tax applies to 'fund payments' made to foreign investors who are tax resident in a country that has an information exchange agreement with Australia¹; and
2. MIT capital account safe harbour: that is, the MIT may elect to apply the capital gains tax (CGT) provisions as the primary code for taxing gains and losses on the disposal of eligible assets (namely a share in a company, non-share equity, a unit in a unit trust, land - including an interest in land and a right to acquire or dispose of any of these assets)²

These are important measures to encourage investment and in promoting Australia as a regional financial services centre. 

The definition of an MIT is core and fundamental to access these concessions. In order to qualify as an MIT, there are a number of conditions that must be satisfied. These conditions are discussed in some detail below. 

One of the requirements is that the trust must be widely held. Under the current test, it is permissible to 'look through' interposed trusts to identify the number of underlying 'members' of the fund to determine if the trust is widely held. However, it is not possible to look through limited partnerships or companies (which are commonly used in international fund of fund structures). This can make it difficult for international or global fund of funds to 'count' in applying the widely held tests. 

On 21 December 2012, The Hon Bill Shorten MP announced that following consultation with industry, the Gillard Government will “make legislative amendments to allow funds to trace through to underlying investors for the purposes of applying the widely held and concentration tests” as set out in the investment manager regime (IMR) provisions. These amendments will allow tracing through common structures such as feeder funds to their underlying members for the purpose of applying the widely held test in the IMR. The amendments have not yet been released but will be introduced in the first half of 2013.

There is a similar deficiency in the way the widely held test applies under the MIT rules. It is not clear that these IMR amendments will apply to allow a similar 'look through' for the purposes of applying the widely held test under the MIT rules. The current rules in effect apply a domestic notion of a permitted 'look through' vehicle (i.e. a trust) for the purposes of attracting foreign and international capital. However, as noted below, this can narrow the circumstances in which these concessions may be available and therefore effective in attracting foreign capital.

For completeness, we have outlined below all of the requirements that must be satisfied by a trust in order to qualify as an MIT and be eligible for the MIT tax concessions outlined above.

MIT Condition 1: the trust must be an Australian resident trust

In order to qualify as an MIT, the trust must have a relevant connection to Australia. 

That is, 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 trustee of the trust must be an Australian resident or the central management and control of the trust must be in Australia.

MIT Condition 2: the trust must not be a trading trust

Where the trust is a unit trust it must not be a ‘trading trust’ in relation to an income year.

In any other case, the trust must not be carrying on a trading business or controlling the carrying on of such a business in relation to the income year.

MIT Condition 3: investment management activities in relation to the trust should be carried out largely in Australia in respect of Australian assets

A substantial proportion of the investment management activities in relation to the Australian assets of the trust (as listed below) must be carried out in Australia:

• assets that are situated in Australia at any time in an income year; 

• assets that are taxable Australian property at any time in the income year; and

• assets that are shares, units or interests listed for quotation in the official list of an approved stock exchange in Australia at any time in the income year.

However, we note that investment management activities outside Australia are permissible for the purposes of applying the MIT capital account safe harbour rules.

MIT Condition 4: the trust must be a managed investment scheme (MIS) under the Corporations Act 2001

At the time the payment is made, the trust must be an MIS as defined by section 9 of the Corporations Act 2001. 

This generally requires that the trust has at least 2 members. A trust that has a single member may be treated as an MIT for the purposes of the MIT capital account safe harbour election rules provided that single member is a specified widely held entity (refer below).

MIT Condition 5: the trust must be widely held

In order to qualify as an MIT, both registered and unregistered schemes must be 'widely held'. Different tests apply to retail and wholesale funds to determine if the trust is widely held.

For the purposes of determining the number of members of the fund:

• if an entity holds an indirect interest in the unregistered MIS (i.e. through a trust or a chain of trusts other than a trust that is a specified widely held entity), that entity is counted as a member of the unregistered MIS and the interposed trusts are ignored; 
• individuals, their relatives, and any entity acting as a nominee of either are treated together as being one entity; 
• non-individuals and any entity acting as a nominee of the non-individual are treated together as being one entity. However, where the non-individual is a specified widely held entity, it is deemed to represent 50 notional members.

Specified widely held entities

The following specified widely held entities will be deemed to represent 50 notional members and will be excluded from the closely held test under the MIT definitions:

1. a life insurance company;
2. a complying superannuation fund, a complying approved deposit fund or a foreign superannuation fund, being a fund that has at least 50 members;
3. a pooled superannuation trust that has at least one member that is a complying superannuation fund with at least 50 members;
4. a managed investment trust in relation to the income year;
5. an entity that is recognised under a foreign law as being used for collective investment by means of pooling the contributions of at least 50 members of the entity as consideration to acquire rights to benefits produced by the entity, if the members of the entity do not have day-to-day control over the operation of the entity;
6. an entity, the principal purpose of which is to fund pensions (including disability and similar benefits) for the citizens or other contributors of a foreign country, if:
   1. the entity is a fund established by an exempt foreign government agency; or
   2. the entity is established under a foreign law for an exempt foreign government agency; or
   3. the entity is a wholly-owned subsidiary of an entity mentioned in subparagraph (i) or (ii);
7. an investment entity that satisfies all of these requirements:
   1. the entity is wholly-owned by one or more foreign government agencies, or is a wholly-owned subsidiary of one or more foreign government agencies;
   2. the entity is established using only the public money or public property of the foreign government concerned;
   3. all economic benefits obtained by the entity have passed, or are expected to pass, to the foreign government concerned;
8. an entity established and wholly-owned by an Australian government agency, if the capital of the entity, and returns from the investment of that capital, are used for the primary purpose of meeting statutory government liabilities or obligations (such as superannuation liabilities and liabilities arising from compensation or workcover claims);
9. an entity of a kind similar to an entity mentioned in the preceding paragraphs of this subsection as specified in the regulations.

Specified widely held entities are deemed to represent 50 notional members. Specifically, the number of notional members represented by interests held by specified widely held entities is calculated as follows:

• determine the MIT Participation Interest (expressed as a percentage) for each specified widely held entity;

• sum up the total of the those interests; and

• multiply that total by 50 (rounding up to the nearest whole number).

Where the trust is held entirely by specified widely held entities, the trust is taken to have 50 members (e.g., 100% [i.e. percentage held by specified widely held entities] x 50 = 50). Accordingly the widely held test should be satisfied for wholesale funds where 50% or more of the membership interests issued by the fund are collectively owned by specified widely held entities (i.e. 50% x 50 = 25, so the widely held test is satisfied).

The MIT participation interest

The MIT participation interest of an entity in the trust is the greatest of the percentages of the following (whether held directly or indirectly):

• interests, or the right to acquire interests, representing a percentage of the value of the interests in the trust; 

• control of, or the ability to control, a percentage of the rights attaching to membership interests in the trust; or

• the right to receive a percentage of any distribution of income that the trust may make.

Example

The following example is included to demonstrate these calculations. This is Example 5.8 extracted from the Explanatory Memorandum to Tax Laws Amendment (2010 Measures No.3) Bill 2010.

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:

The INS Trust will be treated as having the equivalent of 20 members from the life insurance company (50 × 40%) and 15 members from the pooled superannuation trust (50 × 30%). The total membership of the INS Trust, for the purposes of applying the widely held test is 39 being 20+15+4 being the other four members.

Importantly, we note that the INS Trust would be required to be a registered scheme rather than an unregistered scheme as contemplated by the EM unless all of the investors are wholesale clients or unless an exemption under the Corporations Act applies. Where the INS Trust was a registered scheme (with the additional governance and integrity that accompanies registration), then the INS Trust would fail to qualify since it does not have 50 members and the units are not listed on an approved stock exchange.

Although it is permissible to 'look through' a trust to determine the relevant 'member' of the fund and whether that member is a specified widely held entity, it is currently not possible to look through limited partnerships or companies (which are commonly used in international fund of fund structures). This makes it difficult for international or global fund of funds to qualify as a specified widely held entity for the purpose of applying the widely held tests. The current rules, in effect, apply a domestic notion of a permitted 'look through' vehicle (a trust) for the purposes of attracting foreign and international capital. Only time will tell whether the amendments proposed by The Hon Bill Shorten MP will extend to the MIT regime but it is considered that such an extension would be consistent with the realities in commercial and international markets.

MIT Condition 6: the trust must not be closely held

Where the trust is closely held (e.g., 75% of the interests are held by fewer than 20 persons) then the trust will not be eligible to be an MIT. This requirement applies at all times and raises difficult investor tracing requirements, which may be difficult to evidence or satisfy without details of underlying investors on a 'look through' basis. Accordingly some practical or sensible 'rule of thumb' approach must be adopted.

Widely held concessions in start up and end years

The widely held and closely held requirements are taken as satisfied:

• if the trust is created during the 6 months immediately prior to the start of the income year and ending at the end of the income year;

• if the trust ceases to exist during the income year and was an MIT in relation to the previous year of income.

This makes the MIT capital account safe harbour election critical since the election must be made during the first year that a trust qualifies as an MIT. Where an election is not made in that first year, then a deemed revenue treatment applies to certain assets. Accordingly, it is critical to determine if the trust first qualifies as an MIT in its start up year. The election once made is also irrevocable.

MIT Condition 7: the trust is operated or managed by a financial services licensee or authorised representative

The license requirement is implicit for registered schemes (that is, retail funds and wholesale funds which are registered schemes) since they must have a trustee that holds an Australian financial services licence under the Corporations Act, 2001. For wholesale funds that are unregistered schemes, there is a separate and additional 'tax' licensing requirement, as summarised below.

At the time of the first fund payment the (wholesale) trust must be operated or managed by a financial services licensee, authorised representative or be a qualifying sovereign fund as follows:

• the trust is operated or managed by a financial services licensee (within the meaning of section 761A of the Corporations Act 2001) holding an Australian financial services licence whose 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); or an authorised representative (within the meaning of section 761A of that Act) of such a financial services licensee; or

• the trust is operated or managed by an entity that being the Crown would (but for subsection 5A(4) of the Corporations Act (about the Crown not being bound by Chapter 6CA or 7 of that Act)) be required under the Corporations Act 2001 to be a financial services licensee (within the meaning of section 761A of that Act); or

• the trust is operated or managed by an entity that is a wholly-owned subsidiary of the Crown referred to in (b) and is an entity that would, but for any instrument issued by ASIC under that Act that has effect in relation to the entity and the operation of the scheme mentioned in paragraph 12-400(1)(d), be required under the Corporations Act 2001 to be a financial services licensee (within the meaning of section 761A of that Act).

This guide is not advice and should not be relied upon as such. You should always seek specific advice in relation to your specific facts and circumstances.

As stated at the outset, the definition of an MIT is core and fundamental to access the MIT concessions. Should you require any assistance to confirm the MIT qualifying status of your investment or investment vehicle for tax purposes, then please contact the author or one of the other Minter Ellison tax advisers noted below.

Annexure A – withholding rates for fund payments by MITs

Karen Payne is a Partner in Minter Ellison, Lawyers, in the Sydney practice, specializing in corporate and international tax. Karen deals widely in funds management and financial services taxes. Her expertise spans funds structuring, managing investment trusts (rules and withholdings), international investor advice for Australian funds, domestic investor advice for Australian and international funds, and private equity. Karen is also a member of the expert panel assisting the Board of Tax with its reviews of Managed Investment Trusts, Collective Investment Vehicles and Venture Capital Limited Partnerships. She is both an associate with the Institute of Chartered Accountants and a Fellow of the Taxation Institute of Australia.

Minter Ellison is one of the Asia Pacific's leading law firms. Established in Sydney in 1827, our firm today operates in Australia, Hong Kong, mainland China, Mongolia, New Zealand and the United Kingdom through a network of integrated offices and associated offices. Our financial services team is independently recognised (both nationally and internationally) as a leading financial services practice. Our success has been driven by in-depth industry expertise of our lawyers and our commitment to work closely with clients to deliver seamless service wherever they need us. Our strong technical skills, underpinned by the ability to deliver commercially practical solutions that assist clients to achieve their business goals and objectives, have led to our firm's involvement in some of the Asia Pacific's most innovative and high-profile transactions. For more information, please visit www.minterellison.com.

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