The Future of Unit Trusts in Australia

Introduction

In early June 2015 the Federal Government released the Board of Taxation’s report on tax arrangements applying to collective investment vehicles in Australia (Board).

If the Board’s recommendations are accepted it will fundamentally change the funds management industry in Australia. In short, the Board’s report recommends the breaking of the near monopoly of the role of the unit trust over collective investment vehicles in Australia.

Earlier information received by the Board clearly highlighted that offshore investors are dissuaded from investing in Australian funds because, at its core, they do not understand unit trusts, and if there was a greater range of collective investment vehicles available then the Australian fund management industry would be able to better compete with offshore fund managers. This is a position that has been further supported in the interim report of the Murray Inquiry.

To increase the industry’s competitiveness the Board recommends offering additional collective investment vehicles the same tax neutrality as unit trusts, if they exhibit certain collective investment vehicle (CIV) characteristics. In this regard the Board’s report referred to the experiences of Ireland and Luxembourg and the development of 3 additional vehicles be given CIV status in Australia.

These characteristics are outlined as follows:

CIV Characteristics

• Corporate CIV

To be modelled on the Luxembourg SICAV (i.e. an investment company with variable capital). As with open-ended collective investment schemes, the investor is in principle entitled at all times to request the redemption of their units and payment of the redemption amount in cash.

CIVs established as companies will need flexibility to allow investors to withdraw their investments, requiring amendments to the Corporations Act 2001 (Cth) restrictions on redeeming and buying back shares and reducing share capital.

• Limited Partnership CIV

A partnership managed by a general partner (which has unlimited liability for partnership debts), with passive limited partners (whose liability is limited to their investment in, and commitment to, the partnership).

A common private equity fund structure outside Australia; within Australia its use is generally limited to venture capital funds to take advantage of favourable tax treatment limited to those funds.

• Common Contractual Fund CIV (CCF)

Commonly used in Ireland as a collective investment undertaking, under which investors participate and share in the assets of the undertaking as co-owners by contractual arrangement. The CCF is an unincorporated body, not a separate legal entity. As a result, investors in a CCF are treated as if they directly own a proportionate share of the underlying investments of the CCF, rather than shares or units in an entity which itself owns the underlying investments.

The Irish CCF is established by a management company that is vested with powers for the management of the property of the fund. A CCF will also generally have a custodian in which the property of the CCF is entrusted. Investors in a CCF have their liability limited to the amount of their investments.

No Change to Existing CIVs

The Board did not propose any change to Australia’s existing CIVs, including listed investment companies, managed investment trusts or venture capital limited partnerships/early stage venture capital limited partnerships – or to their tax treatment.

When would the proposed additional vehicles enjoy CIV-status?

The Board recommended that a corporate CIV, a limited partnership CIV, or a CCF CIV should enjoy CIV status if it has the following broad characteristics. In general terms, CIV status would confer on it the proposed tax outcomes set out below. These characteristics would be already familiar to fund managers, investors and advisers, as they are similar to those which apply to managed investment trusts:

• It is widely held, on a look-through basis;
• It engages mainly in passive investment activities;
• It does not carry on a trading business, or control another person that carries on a trading business; and
• Finally, it is an Australian resident and, if it is to have access to the concessional withholding tax rate on fund payments presently available to managed investment trusts, it should have a significant connection with Australia.

Proposed tax outcomes

Corporate CIV

• Exempt for tax purposes, with the intention of passing the tax burden on to its shareholders;
• Required to pay dividends to shareholders periodically, with the dividends being equal to a substantial proportion of what would be the taxable income of the corporate CIV;
• Required to have a substituted accounting period of sufficient length to enable it to pay final dividends in respect of that period by 30 June;
• Resident shareholders to be taxable at the time they receive dividends;
• For foreign shareholders, dividends are to be treated as amounts not subject to dividend withholding tax where the dividend comprises foreign income, non-taxable Australian property capital gains or franked dividends, with all other amounts being subject to dividend withholding tax;
• A special rate of dividend withholding tax to apply for dividend payments made to foreign shareholders resident in an information exchange country that produces a tax outcome equivalent to the application of Australia’s different treaty withholding tax rates for different types of payments to foreign shareholders; and
• Corporate CIVs to have the option to elect deemed CGT treatment, similar to that for managed investment trusts.

Limited Partnership CIV

• General partnership tax rules to be applied to provide flow-through taxation for the limited partnership CIV. Limited partnership CIVs to be subject to loss limitation rules similar to those in the foreign hybrid limited partnership regime;
• The final withholding tax on fund payments made by a limited partnership CIV possibly to be aligned with that applying to managed investment trusts; and
• Limited partnership CIVs to have an option to elect deemed CGT treatment similar to that introduced into the managed investment trust regime.

CCF CIV

• Should provide tax flow-through treatment;
• Investors in a CCF CIV receive flow-through of character and source similar to investors in an limited partnership CIV, with no need for a cost base at the CIV level as is the case under the managed investment trust regime;
• The profits (income and gains) arising or accruing to a CCF CIV to be treated as rising or accruing to the investor in proportion to the value of the assets beneficially earned by them, as if those profits did not pass through the hands of the CCF CIV;
• Final withholding tax on fund payments possibly to be aligned to that applying to managed investment trusts; and
• CCF CIVs to have the option to elect the CGT treatment for its eligible investments.

Where to now?

It has taken a long time to get to this point so it would be a brave person who would suggest that these changes would be introduced in the near short term. Treasury is currently consulting with various parties. However, these changes are an important complement to the Asia region funds passport arrangements.

One Investment Group is anticipating further changes to the CIV regime in the future. We intend to monitor the progress of the current and future changes as they affect our clients and the broader industry.

For all questions concerning foreign investment into Australia and the CIV regime please contact Justin Epstein on +612 8277 0000.