The Crest of the Commonwealth of Australia Treasury Portfolio Ministers
Picture of Nick Sherry

Nick Sherry

Assistant Treasurer

9 June 2009 - 14 September 2010

Speech of 07/05/2010

NO.015

A New Tax System for Managed Investment Trusts

Address to the IFSA and Clayton Utz Industry Luncheon

Clayton Utz, Sydney

7 May 2010

Introduction

Good afternoon.

Thank you for inviting me to speak to you to today.

It is always a pleasure to come and speak at an IFSA event. Thank you particularly to John Brogden, IFSA's CEO.

I would also like to acknowledge the CEO of the Property Council of Australia, Mr Peter Verwer.

I have just arrived back yesterday from the Asian Development Bank Annual Meetings and the first ever East Asian Summit Finance Minsters Meeting in Tashkent, in Uzbekistan.

Long trip, but certainly worth it.

I held key talks with finance and economic Ministers from China, India, Vietnam, Korea and any number of other global and regional economies, and I can confirm that they all still see Australia as having come through the storm that was the global financial crisis better than any developed country.

And their views are indeed accurate.

I don't need to repeat the facts here today.

But what I do want to say is that one of the key reasons for this outcome is the strength of our financial services, banking and funds management sectors.

They are large, stable and well regulated.

And a key feature of that size is the managed investment trust, or MITs, and the sector that manage them.

MITs are trust funds for collective investment that are usually passive, widely held, diversified and long term.

Many millions of Australians are invested in MITs – either directly or indirectly through superannuation funds.

According to Tax Office data, there were approximately 634,000 individual taxpayers who are not a company and reported receiving a distribution from a MIT – 630,000 of these were residents and 4,000 were non-residents.

In addition, there are approximately 276,000 businesses superannuation funds which are unit holders in MITs.

As you are no doubt aware, the Board of Taxation has completed its final report on its review of the tax arrangements applying to managed investment trusts (MITs) and it gives me great pleasure today to be able to announce the Government's response to the Board's final report.

However, before I get to that I would first like to discuss a few other issues that are of importance, not only to the investment and financial services industry, but to the Australian economy more broadly, that is, Australia's outstanding economic performance and the Government's new tax reform package that was announced last weekend.

The Australian Economy

Australia's economic performance in 2009 has been remarkable considering the impact the global financial crisis has had on the global economy.

The IMF in its April World Economic Outlook estimates that the global economy contracted by 0.6 per cent in 2009, with advanced economies contracting 3.2 per cent.

This was the first recorded decline in both advanced economy and global growth since World War II.

In contrast, the Australian economy grew by 1.4 per cent in 2009 while the unemployment rate fell to 5.3 per cent in March 2010, the second lowest rate of any of the major advanced economies, with the exception of Japan.

This solid performance in large part reflects the success of both monetary and fiscal stimulus in Australia which helped to boost domestic confidence in the face of the global downturn.

Indeed, Treasury estimates that without the fiscal stimulus the economy would have contracted by 0.7 per cent in 2009.

The fiscal stimulus is now detracting from growth as the private sector is once again expanding.

Fortunately the outlook for the global economy for the current year is much brighter with the IMF forecasting growth of 4.2 per cent.

Against this more positive backdrop, the IMF has upgraded its outlook for Australia with growth of 3.0 per cent expected in 2010. This outlook is stronger than that for advanced economies as a whole, which are forecast to grow collectively by 2.3 per cent in 2010.

The mining sector will underpin our growth recovery as demand for our commodities strengthens. We are already seeing higher prices for our non‑rural commodity exports which should lead to a higher terms of trade, strong incomes growth, and strong investment growth.

The Government will be releasing its own updated economic forecasts next Tuesday when the Treasurer delivers his third Budget.

The Henry Review and What This Means for Australia's Long-Term Sustainability

This week the Government announced our tax reform package, Stronger, Fairer, Simpler: a Tax Plan for our Future, to make the most of opportunities presented by the current resources boom and to address the challenges that it presents.

As you know, this long-term plan applies a Resource Super Profits Tax to the profits from resources that all Australians own, and uses the revenue to:

  • generate more superannuation savings for working families
  • lower tax for all companies, especially small businesses, and
  • invest in our future infrastructure needs, particularly for mining states.

The Resource Super Profits Tax will ensure Australians get a fair share from our valuable non-renewable resources. It only starts to tax profits after the point where shareholders have received a normal return on their investment. It fully recognises the large investments made in resource projects.

The revenues will be used to deliver a stronger economy for Australian families. Around a third of the package will directly assist the resources sector. A Resource State Infrastructure Fund will make infrastructure spending a permanent feature of Commonwealth and State budgets. And a Resource Exploration Rebate will encourage further exploration.

Around a third of the package will ensure we save rather than squander the benefits of the current boom, and translate the higher economic growth and wages we are currently enjoying into long-term benefits and more secure retirements.

Of particular importance to IFSA and its members is the Government's decision to gradually increase the Superannuation Guarantee to 12 per cent. This will increase the retirement incomes of around 8.4 million Australians, including 3.5 million lower paid Australians who will receive a tax concession on their Superannuation Guarantee contributions, for the first time.

Over 50s with lower super balances will be given more generous contribution caps to allow them to make catch up contributions - and the higher Superannuation Guarantee age - 75 from 1 July 2013 - will benefit around 33,000 employees.

Over the next 10 years, the Government's superannuation changes will add $85 billion to Australia's pool of superannuation savings. Some of these savings will be channelled back into the Australian economy to fund jobs and nation-building infrastructure, ensuring our reliance on foreign funds is lower than it otherwise would be.

Another third of the package will promote growth across the economy, addressing the risk of a "two-speed economy" by taking the brakes off the slower lane.

A phased cut in the company tax rate to 28 per cent will assist the competitiveness of all Australian industries. The Government will also seek to cut the company tax rate further, as fiscal circumstances allow.

Small businesses will get a head start on the company tax cut, with the 28 per cent rate applying from 2012‑13.

The Resource Super Profits Tax and the cuts in the company tax rate, taken together, will increase Australian GDP by 0.7 per cent and increase real wages by 1.1 per cent in the long run.

The Stronger, Fairer, Simpler package depends on successfully implementing the Resource Super Profits Tax. This tax generates the revenue needed to fund the other parts of the package and a large part of the economic gains from the package.

The Government understands the challenges of tax reform. Simplifying the system often means doing away with favourable treatment for particular groups. Often their expressions of disapproval can drown out the support of the broader community.

So we know tax reform will meet opposition – indeed we have seen the Opposition vow to do just that – but we also know the gains can be really substantial.

The Stronger, Fairer, Simpler package is a solid and fiscally responsible start to the long-term project of tax reform. It's not possible to reform the whole of the system in one package and it would have been foolish of us to try.

The Stronger, Fairer, Simpler package will yield important gains for Australia.

A New Tax System for Managed Funds

But now to the financial services sector, and in particular to MITs.

As you would all be too sorely aware, there is a high degree of uncertainty surrounding the tax law applying to trusts generally and to MITs specifically.

The tax law has not changed to keep pace with the modern day use of trusts as collective investment vehicles.

Historically, trusts were invented by English nobles around the 13th century in order to avoid the payment of estate duties.

The concept of the trust developed in English law, over a number of centuries thereafter, chiefly as a result of efforts of conveyancers to preserve the land holdings of their clients from certain forms of feudal taxation and to increase the number of dispositions of land which their clients could legally make on death.

When much of the law governing trusts was developed, trusts were essentially simple relationships between an individual trustee and a small number of beneficiaries in respect of authorised investments such as land or shares.

However, the times have certainly changed.

And there has been a particularly strong growth in the use of unitised trusts as MITs.

As I said earlier, MITs now hold assets that are ultimately owned by many millions of Australians via their superannuation accounts and many hundreds of thousands of direct investors.

But industry bodies, such as IFSA, have long been concerned that the outdated trust tax arrangements could impede international competiveness in attracting funds under management.

Even before the Rudd Government came to office we recognised that reform to the taxation of managed funds was essential to Australia's long term economic performance.

In August 2007 we announced that a Labor Government's first reference to the Board of Taxation would be a review of the tax arrangements applying to managed funds.

The Government fulfilled this election commitment in February 2008.

The Board was tasked with providing options for introducing a specific tax regime for MITs to reduce complexity, increase certainty and minimise compliance costs.

We asked that the reform options provided to the Government be revenue neutral.

In addition to the Board's review, and in recognition that the review would take some time, the Government introduced interim reforms in 2008 to streamline and modernise the eligible investment business rules in Division 6C of the Income Tax Assessment Act 1936.

These interim reforms were an important step forward.

They reduced the scope for managed funds, particularly property trusts, to breach the eligible investment business rules inadvertently, thus lowering compliance costs for industry.

On 10 February 2010 the Government took another step in this process of reform by introducing legislation into Parliament to allow eligible MITs to make an irrevocable election to apply capital account treatment to gains and losses made on disposals of certain assets, primarily shares, units and real property.

These changes implement interim advice received from the Board as part of its Review.

Providing deemed capital account treatment for eligible MITs will reduce complexity and compliance costs and improve the global competitiveness of the Australian funds management services industry. As a result of these changes MITs and investors will have certainty about when they can access CGT concessions on gains.

Further to the announcement on 10 February 2010, the Government recently released draft legislation on proposed changes to the general definition of a MIT and we are in the process of consulting with stakeholders on these changes.

These changes will provide a much closer alignment of the definition to be used for both the MIT withholding tax rules and the capital account rules.

This will also provide further certainty in relation to the operation of the MIT withholding tax rules, which build on the Government's efforts to promote Australia as a financial services hub and promote the Australian funds management industry.

This final withholding tax regime has applied from 1 July 2008 for certain payments from MITs to foreign residents of countries with which Australia has effective tax information exchange.

A 22.5 per cent rate applied in the first year of operation, falling to 15 per cent for the current income year, and soon to fall to 7.5 per cent for payments in respect of the year beginning 1 July 2010.

Full Government Response To Board Of Tax MIT Review

Today, I am very pleased to be here with IFSA to move this project to its next level through the most significant step in the managed fund reform process to date.

I am of course referring to the Rudd Government's response to the Board's report on its review of the tax arrangements applying to MITs, which I am extremely happy to release today, along of course with the Board's report itself.

I would like to thank the Board for undertaking the review – the work is, as usual, of an exceptional quality and makes an extraordinary contribution.

I can announce this morning that the Rudd Government will put in place a whole new tax system for the treatment of MITs.

We will do this by accepting and implementing the majority of the Board's 48 recommendations, including a dedicated tax regime for MITs.

This new system will commence on 1 July 2011.

Implementing the majority of the Board's recommendations will increase certainty, reduce complexity and minimise compliance costs for managed funds and the industry more generally.

The Government's response to the Board's review will boost the global competitiveness of the Australian tax regime for attracting foreign funds under management and provide broader economic benefits to Australia.

The outcome of the changes will be increased investment, more Australian jobs in financial services and a more profitable and efficient funds management industry.

The changes will also directly benefit almost every single Australian who, although they may not be fully aware of it, have extensive investments in MIT structures through their super funds. They're in addition to the 630,000 individual Australian taxpayers and 276,000 businesses and superannuation funds who received a distribution from a MIT in 2008, as mentioned earlier.

There are number of significant elements to the Government's reform package for the taxation of MITs.

First, as I mentioned, the Government will introduce a specific new tax system for Australian MITs, being, again as mentioned earlier widely held collective investment trusts which are engaged in primarily passive investment.

This new tax regime, worth $120 million over the forward estimates, will boost jobs, boost the economy, and see less reliance on archaic trust law concepts and the new arrangements will be better tailored to the modern day use of trusts as collective investment vehicles.

As part of the new tax regime, qualifying MITs, that is, those whose investor beneficiaries have clearly defined rights/entitlements under the trust's constituent documents, will be able to elect to use an attribution system of taxation as a basis for determining when an investor is liable to taxation, rather than the current system that relies on the concept of present entitlement to trust income.

The attribution model will sweep away the inconsistent interaction of Australia's tax law with our trust law, which relies on centuries of development and precedent.

It means taxpayers will, for the first time, have absolute certainty in the tax that will be imposed.

This new attribution system will provide that investors will be only assessable on the taxable income that the trustee allocates to them on a fair and reasonable basis, consistent with their entitlements under the trust deed or the trust constituent documents.

The current present entitlement system can lead to unintended taxation outcomes, such as investors being assessed on capital gains that are paid to other beneficiaries or retained in the trust.

While the recent High Court of Australia decision in the Bamford case went some way towards increasing certainty in the operation of the tax laws for certain trusts, there is still some uncertainty for other trusts.

The attribution method of taxation will provide MITs and their investors with greater certainty in respect of who is liable to tax on the taxable income of the trust. This will reduce the risk of these unintended taxation outcomes arising.

As other trusts must continue to use the present entitlement system in Division 6 of the Income Tax Assessment Act 1936, I have sought advice from Treasury and the Australian Taxation Office on the broader implications of the High Court's decision in Bamford and on whether changes will be needed.

The second key element to the new tax system for MITs will be the introduction of a legislated carry-forward system for all MITs to deal with "over or under" distributions within a five per cent cap so, that MITs are not required to reissue statements and over 900,000 individual, business, or superannuation fund investors are not required to revisit tax returns

This new system will reduce complexity and provide more certainty for managed funds about when they will be required to re-issue tax distribution statements to investors. Under the new rules, the need to re-issue statement should be significantly reduced.

This is a significant simplification of the Australian tax law.

The third core feature of the new tax system for MITs is important amendments to the capital gains tax rules to prevent double taxation.

Double taxation can occur, in certain circumstances, when a distribution to a unit holder is less than their share of the trust's taxable income.

This is a reasonably wide problem and its effect is often hidden from trust beneficiaries because it is "net within the trust".

The current system of downward cost base adjustments will be supplemented by upward cost base adjustments in certain circumstances. So, the operation of these anomalies is being clarified to remove double taxation.

Finally, the Government will repeal the corporate unit trust provisions in Division 6B of the Income Tax Assessment Act 1936, which was initially introduced in 1981 to protect the company tax base, but has since become redundant, and replace it with a general arm's length rule in the public trading trust provisions in Division 6C of the Income Tax Assessment Act 1936.

This repeal removes complicated and uncertain provisions which no longer have application. Its ongoing inclusion in the tax law led to confusion in the minds of investors and potential investors, both in Australia and internationally.

This repeal with significantly boost certainty.

Of course, all these changes will also support our work to enhance Australia as a financial services hub.

The Board consulted widely in developing the recommendations in its report.

It issued a discussion paper and undertook targeted consultation with selected stakeholders representing a diverse range of views and held consultation meetings which were open to all stakeholders.

It also established an expert panel to develop its final recommendations.

The Government will also consult widely with industry and key stakeholders on the implementation details.

I will issue a paper on detailed design issues for consultation in the near future.

We look forward to IFSA's, and indeed Clayton Utz's, participation in this process.

Due to our commitment to fiscal responsibility, the Government has decided to defer consideration of a small number of recommendations of the Board to further assess their benefits, relative to the potential cost to revenue.

But as I said, we are accepting the vast majority of the Board's reform suggestions have been fully accepted.

Indeed, those I have just run through are merely the top-level reforms we are implementing.

There are many more that collectively fill out the new tax system for MITs which is a complete re-write that will fundamentally reshape how these critical trusts are used and grow.

The Board's full report and the Government's full response will be available on the Board of Taxation's website later today.

Conclusion

What I have announced today is a significant reform package for the taxation of MITs, which builds on a number of previous Government initiatives for managed funds.

The $120 million cost over the immediate forward estimates is, in the Rudd Government's view, an appropriate investment well worth making to boost the investment returns of millions of Australians and to enhance your critical industry.

These changes do really represent a revolution in the provision of clarity in the taxation of investments held within the MIT structure.

Investors now will absolutely know where they stand in terms of their taxation outcomes.

This will remove the brakes that exist on investment within Australia and on external investment sourced through these sorts of trusts.

There will be many important flow-on outcomes of the changes.

The increased investment from and into Australia will boost economic activity and growth.

There will be more high-paying, skilled Australian jobs in financial, wealth management and related services.

And for those in the industry such as IFSA members – there will be higher local fund manager profitability and efficiency.

Thank you.