Government introduces revised definition of MIT
26 May 2010
Subsequent to submissions in relation to the Exposure Drafts released by the Government on 16 April 2010 dealing with amendments to the definition of a MIT, amendments (in the Senate) were made to oppose certain provisions in Schedule 3 of Tax Laws Amendment (2010 Measures No. 1) Bill 2010 dealing with capital account treatment for MITs.
AVCAL is very pleased to announce that after extensive consultation with Assistant Treasurer Nick Sherry, his advisers and the Treasury, we have achieved most of our desired outcomes in the legislation which is currently before parliament. The Government has been extremely helpful in its consultation process with AVCAL.
The Government has today introduced Tax Laws Amendment (2010 Measures No 3) Bill 2010 to the House of Representatives. Schedule 5 to this Bill deals with the definition of a Managed Investment Trust (MIT). You can also view the Assistant Treasurer's press release here.
These developments should not be confused with some recent media reports that suggesting the legislation has a negative impact. Those reports reference the registered Managed investment Schemes (used by trusts for retail investors and some wholesale investment funds) which are dealt with differently to the unregistered trusts which are applicable to the majority of domestic private equity funds. With so much confusion even the government is moving to clarify the language.
To bring AVCAL members up to date on the key points of the legislation, AVCAL Chief Executive Dr Katherine Woodthorpe talked to Ian Scott, tax partner at Ernst & Young who played a critical role in helping us deliver this positive outcome for our industry. The discussion points raised below are by no means comprehensive as every fund has a unique structure and circumstance and AVCAL recommends that you talk to your own tax advisor to understand the direct implications for you.
Katherine Woodthorpe (KW): Can you outline for our members the changes the government has made that affect private equity (PE)?
Ian Scott (IS): The government introduced legislation for the irrevocable capital election into the law for Managed Investment Trusts (MITs) in Tax Laws Amendment (2010 Measures No. 1) Bill, which has now passed through parliament. In addition the government broadened the definition of MITs in Tax Laws Amendment (2010 Measures No. 3) Bill, introduced on 26 May for purposes of the irrevocable capital election and also for purposes of the withholding tax on distributions to non-resident investors. Private Equity (PE) funds which are eligible to be MITs will be able to benefit from both the irrevocable capital election and reduced tax withholding rules. AVCAL was extensively involved with Treasury, the Minister and his advisors in the process for defining eligible MITs for these concessions.
KW: What years will the irrevocable capital election apply for?
IS: The legislation is retroactive as well as prospective. As such, it will apply to the years ended 30 June 2009 and 2010 where the MIT definition is satisfied in those years. It can also apply to prevent the Commissioner amending earlier year assessments. It is important to know that it is also irrevocable for future years.
KW: Do the reforms apply to all PE Funds?
IS: The capital election is available to all MITs as defined for the purposes of the tax law. Very broadly, it includes Australian widely held funds and funds taken to be widely held. AVCAL was instrumental in allowing unregistered funds, the principal mechanism for private equity Australian funds, to be eligible for consideration as unregistered MITs and the capital election. The proposed definition also covers registered funds, where the rules have not been expressed as effectively and the government is considering potential changes. The law is currently before parliament and this should be reviewed in the context of your individual circumstances, including the requirements for acceptance as a widely held fund.
The broad definition of a widely held unregistered fund is one with at least 30 members at the time of making its first distribution for the year. Special counting rules apply for the treatment of certain investors, including life insurance companies, superannuation funds, other MITs and nominees.
A 'closely held' test excludes funds from the MIT concessions if 12 or less members of the trust hold a 75% or more participation interest in a year. This is relevant for PE funds in relation to the treatment of Free Carry interests.
As before, MITs are excluded if a foreign resident individual holds a 10% or greater interest in the fund.
KW: I've seen some concern about the application of the definition in the media, can you clarify this definition for our members?
IS: There are some outstanding issues that relate primarily to the treatment of registered funds under the proposed definition. Generally, private equity funds structured as Australian trusts are not registered trusts and those concerns do not apply. Ernst & Young and various industry bodies have been consulting with Treasury on the formulation of the definition as it applies to registered funds and Government has demonstrated that it is keen to reach a favourable and workable resolution.
KW: What about the interaction with the Division 6C trading trust rules?
IS: The Government has registered AVCAL's calls for the modification or repeal of Division 6C. A fund which is a trading trust in an income year does not benefit from the election. This is a complex area, and we recommend you discuss the matter with your tax advisor.
KW: Are there other pitfalls PE Funds should be aware of?
IS: There can be. Whilst the proposals in the bill are a significant step forward, not all PE Funds will qualify. PE Funds should seek detailed advice regarding their unique circumstances, particularly in relation to how the widely held test applies. Where relevant, this takes into account the nature and extent of Free Carry interests.
KW: When will private equity firms need to make decisions regarding the capital election?
IS: The legislation allows 3 months from the date of Royal Assent of the legislation which has not yet occurred. However, for tax distribution computation and notification purposes you will have to make a decision very quickly to ensure that you are prepared for the year end distribution process.
KW: When will we see the final law?
IS: Government is working through the wording of the definition and we are likely to see some amendments shortly. Government is very aware of the need to have the Bill in its final form and through parliament by the end of June 2010, therefore the definition should be clear by 30 June in time for year-end distributions.
KW: Does this capital election apply to all of an eligible MIT's assets?
IS: Generally, the election covers the realisation of investments in shares, non-share equity interests, units and options to acquire or dispose of such assets. There are some exceptions, and we strongly recommend that you discuss them with your tax advisor.
KW: What should private equity firms do next?
IS: Every private equity fund has its own unique position so again we recommend you talk to your own tax advisor. We anticipate that you will need to communicate with your investors to determine their status, including whether they themselves are a MIT (and, if so, in which income years), and if they are a trust, the composition (though not necessarily the identity) of their own investors.