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Income Tax Rates Amendment (Sovereign Entities) Bill 2018
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2016-2017-2018-2019

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

                                                         SENATE                

 

 

 

Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2019



Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018



Income Tax Rates Amendment (Sovereign Entities) Bill 2018

 

 

REVISED EXPLANATORY MEMORANDUM

 

 

(Circulated by authority of the

Treasurer, the Hon Josh Frydenberg MP)

 

THIS MEMORANDUM TAKES ACCOUNT OF AMENDMENTS MADE BY THE HOUSE OF REPRESENTATIVES TO THE BILL AS INTRODUCED

 



Table of contents

Glossary............................................................................................................. 1

General outline and financial impact........................................................... 3

Chapter 1 ........... Non-concessional MIT income....................................... 7

Chapter 2 ........... Thin capitalisation............................................................ 77

Chapter 3 ........... Superannuation funds for foreign residents withholding tax exemption            85

Chapter 4 ........... Sovereign immunity......................................................... 93

Chapter 5 ........... Regulation impact statement....................................... 115

Chapter 6 ........... Statement of Compatibility with Human Rights........ 151

 

 



The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

ADI

authorised deposit-taking institution

AMIT

attribution managed investment trust

ATO

Australian Taxation Office

CGT

capital gains tax

Commissioner

Commissioner of Taxation

GDP

gross domestic product

GFC

global financial crisis

GST Act

A New Tax System (Goods and Services) Act 1999

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

IT(TP)A 1997

Income Tax (Transitional Provisions) Act 1997

MIT

managed investment trust

NANE income

non-assessable non-exempt income

NDIS

National Disability Insurance Scheme

OECD

Organisation for Economic Co-operation and Development

TAA 1953

Taxation Administration Act 1953

this Bill

Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Bill 2019

 

 



Non-concessional MIT income

Schedules 1 and 5 to this Bill amend the ITAA 1997, the ITAA 1936 and the TAA 1953 to improve the integrity of the income tax law for arrangements involving stapled structures and to limit access to tax concessions for foreign investors by increasing the MIT withholding rate on fund payments that are attributable to non-concessional MIT income to 30 per cent.

An amount of a fund payment will be non-concessional MIT income if it is attributable to income that is :

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

The Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018 makes consequential amendments to the Income Tax (Managed Investment Trust Withholding Tax) Act 2008 to specify that the MIT withholding rate on income attributable to non-concessional MIT income is 30 per cent.

Date of effect The amendments apply from 1 July 2019. Transitional rules apply to appropriately protect existing arrangements from the impact of the amendments.

Proposal announced This measure was announced by the Government on 27 March 2018 and published in the 2018-19 Budget Paper No. 2 as ‘Stapled structures — tightening concessions for foreign investors’.

Financial impact :  As a package, the 2018-19 Budget measure ‘Stapled structures — tightening concessions for foreign investors’ is estimated to have the following gain to revenue over the forward estimates period :

2018-19

2019-20

2020-21

2021-22

$30.0m

$80.0m

$125.0m

$165.0m

Human rights implications :  Schedules 1 and 5 to this Bill, and the Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018, do not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 6.

Compliance cost impact Low.

Thin capitalisation

Schedule 2 to this Bill amends the ITAA 1997 to improve the integrity of the income tax law by modifying the thin capitalisation rules to prevent double gearing structures.

Date of effect The amendments apply to income years starting on or after 1 July 2018.

Proposal announced This measure was announced by the Government on 27 March 2018 and published in the 2018-19 Budget Paper No. 2 as ‘Stapled structures — tightening concessions for foreign investors’.

Financial impact :  As a package, the 2018-19 Budget measure ‘Stapled structures — tightening concessions for foreign investors’ is estimated to have the following gain to revenue over the forward estimates period :

2018-19

2019-20

2020-21

2021-22

$30.0m

$80.0m

$125.0m

$165.0m

Human rights implications :  This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 6.

Compliance cost impact Low.

Superannuation funds for foreign residents withholding tax exemption

Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

Date of effect The amendments apply from 1 July 2019. Transitional rules apply to appropriately protect existing arrangements from the impact of the amendments.

Proposal announced This measure was announced by the Government on 27 March 2018 and published in the 2018-19 Budget Paper No. 2 as ‘Stapled structures — tightening concessions for foreign investors’.

Financial impact :  As a package, the 2018-19 Budget measure ‘Stapled structures — tightening concessions for foreign investors’ is estimated to have the following gain to revenue over the forward estimates period :

2018-19

2019-20

2020-21

2021-22

$30.0m

$80.0m

$125.0m

$165.0m

Human rights implications :  This Schedule does not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 6.

Compliance cost impact Low.

Sovereign immunity

Schedule 4 to this Bill will amend the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

The Income Tax Rates Amendment (Sovereign Entities) Bill 2018 makes consequential amendments to the Income Tax Rates Act 1986 to specify that sovereign entities are liable to income tax on taxable income at a rate of 30 per cent.

Date of effect The amendments apply from 1 July 2019. Transitional rules apply to appropriately protect existing arrangements from the impact of the amendments.

Proposal announced This measure was announced by the Government on 27 March 2018 and published in the 2018-19 Budget Paper No. 2 as ‘Stapled structures — tightening concessions for foreign investors’.

Financial impact :  As a package, the 2018-19 Budget measure ‘Stapled structures — tightening concessions for foreign investors’ is estimated to have the following gain to revenue over the forward estimates period :

2018-19

2019-20

2020-21

2021-22

$30.0m

$80.0m

$125.0m

$165.0m

Human rights implications :  Schedule 4 to this Bill, and the Income Tax Rates Amendment (Sovereign Entities) Bill 2018, do not raise any human rights issue. See Statement of Compatibility with Human Rights — Chapter 6.

Compliance cost impact Low.

Summary of regulation impact statement

Regulation impact on business

Impact The compliance costs of the package of measures in Schedules 1 to 5 to this Bill overall involve a low compliance cost impact, comprising a medium implementation impact and a low increase in ongoing compliance costs.

Main points :

•        The package of measures in this Bill comprehensively tackles the various tax settings that are combined with stapled structures to deliver low tax rates to foreign investors and is the most effective option in providing significant revenue protection.

•        Domestic investors will not be disadvantaged when competing for investment under the current tax settings.

•        Some marginal projects could potentially be affected due to the higher withholding tax rate faced by foreign investors. Although tax can have a significant impact on investment decisions, tax is only one of many factors that investors consider in their investment decisions. There are a multitude of other factors that investors consider, such as the regulatory, political and social environment of their investment.

•        The net benefits derived from the significant revenue protection and removal of distortions provided by the package outweigh concerns about increased complexity and compliance costs, as well as the potential impact on investment.

 

 



Outline of chapter

1.1                   Schedules 1 and 5 to this Bill amend the ITAA 1997, the ITAA 1936 and the TAA 1953 to improve the integrity of the income tax law for arrangements involving stapled structures and to limit access to tax concessions for foreign investors by increasing the MIT withholding rate on fund payments that are attributable to non-concessional MIT income to 30 per cent.

1.2                   An amount of a fund payment will be non-concessional MIT income if it is attributable to income that is :

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

1.3                   The Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018 makes consequential amendments to the Income Tax (Managed Investment Trust Withholding Tax) Act 2008 to specify that the MIT withholding rate on income attributable to non-concessional MIT income is 30 per cent.

Context of amendments

MIT cross staple arrangement, trading trust and agricultural income

1.4                   A stapled structure is an arrangement involving two or more commonly owned entities (at least one of which is a flow-through entity), that are often legally bound together such that the interests in them cannot be bought or sold separately.

1.5                   Stapled structures have been used in Australia by the property » sector since the 1980s. Prior to the introduction of the MIT regime in 2008, profits made by stapled entities bore a similar level of Australian tax as if they had been made by companies. Domestic and foreign direct investors were taxed in Australia at their marginal tax rates on business income (although they enjoyed some timing benefits). Generally, foreign investors in managed funds would have paid tax at the corporate tax rate.

1.6                   The MIT regime was aimed at increasing the attractiveness of Australia’s fund management industry (especially « property » funds) to mobile foreign investment. It did this by lowering the withholding taxes deducted from certain distributions to foreign investors from MITs, particularly for distributions attributable to rental income. For members of a MIT who are residents of an exchange of information country, the rate of MIT withholding tax is generally 15 per cent.

1.7                   As a result of the MIT regime, foreign investors investing through stapled structures no longer bear tax at the corporate tax rate. If the trust side of the staple is a MIT, tax is generally withheld on rental income at 15 per cent.

1.8                   This does not raise significant integrity issues for traditional « property » stapled structures. The trust side of traditional « property » stapled structures generally hold portfolios of land assets that derive passive rental income from third party tenants. A lower tax rate on this income is an intended outcome of the MIT regime. Trading activities (for example, « property » development) are undertaken by the company side of the staple, which continues to pay corporate tax. There is no conversion of active income into passive income.

1.9                   Over time, the tax rate differential has encouraged an increase in the use of stapled structures to convert active business income into passive rental income.

1.10               For example, a single business is fragmented between an asset entity and an operating entity. A foreign investor holds an interest in a MIT. The land assets necessary for use in the business are held by the MIT (either directly or indirectly through another asset entity) and leased to an operating entity. The taxable income of the operating entity is reduced by rental payments to the asset entity. The rental payments distributed from the asset entity obtain access to the 15 per cent MIT withholding tax rate when distributed to foreign investors. In this way, the active income of a trading business is converted into concessionally taxed passive income.

1.11               Increasingly, businesses in a broad range of sectors are seeking to access the MIT concession by using stapled structures and other similar arrangements to convert active income into passive income. Further, some foreign investors have entered into arrangements that generate debt greater than the prescribed thin capitalisation debt limits by using ‘double gearing’ structures, leading to the ability to claim greater debt deductions. In some cases, these arrangements have no clear commercial justification other than to reduce effective tax rates for foreign investors. Schedule 2 to this Bill addresses this concern.

1.12               Meanwhile, globally, sovereign wealth funds and pension funds have grown rapidly. As these types of investors have access to a range of additional tax concessions, effective tax rates on distributions from stapled structures for these investors can be between zero and 15 per cent. Schedules 3 and 4 to this Bill address these concerns.

1.13               These concessions combined with a stapled structure can result in very low rates of tax for some foreign investors.

1.14               In effect, stapled structures have resulted in the unintended emergence of a dual corporate tax system that taxes foreign institutional investors in land-rich industries at rates anywhere between zero and 15 per cent. Meanwhile, other large businesses remain subject to the current top corporate tax rate of 30 per cent. This creates a tax bias in investment decisions, potentially drawing capital away from businesses that are capital intensive, knowledge based and/or research and development intensive, rather than land-rich.

1.15               The Government has decided that it is necessary to address the use of stapled structures and to limit access to tax concessions for foreign investors in order to protect the integrity of Australia’s tax system. This will provide more certainty for investors and a fairer and more predictable investment environment in the future.

1.16               Therefore, a final MIT withholding tax set at the top corporate tax rate will apply to distributions derived from trading income that has been converted into passive income using a MIT, excluding rent received from third parties.

1.17               In addition, distributions derived from investments in agricultural land will be non-concessional MIT income that is subject to a final MIT withholding tax set at a rate of 30 per cent.

1.18               The Government also decided as part of the stapled structures package of measures to:

•        close a loophole in the thin capitalisation rules;

•        narrow the superannuation funds for foreign residents withholding tax exemption; and

•        codify and limit the sovereign immunity tax exemption to certain portfolio-like investments.

1.19               These changes are explained in Chapters 2, 3 and 4.

MIT residential housing income

1.20               In the 2017-18 Budget, the Government announced a package of measures designed to improve outcomes across the housing sector.

1.21               Several of these measures specifically address housing affordability for members of the community earning low to moderate incomes by providing incentives for investors to increase the supply of affordable housing.

1.22               States and territories have their own affordable housing policies which are designed to encourage affordable housing investment and the Government’s affordable housing measures are intended to complement these existing policies.

1.23               In the 2017-18 Budget package, the Government announced that MITs would be prevented from investing in residential premises unless they are commercial residential premises or affordable housing.

1.24               Following consultation, the announced approach has been refined to adopt an approach that is more consistent with the stapled structures measures that were subsequently developed.

1.25               As a result, MITs will be able to invest in residential housing that is held primarily for the purpose of deriving rent. However, distributions that are attributable to investments in residential housing that are not used to provide affordable housing will be non-concessional MIT income that is subject to a final MIT withholding tax at a rate of 30 per cent.

Summary of new law

1.26               Schedules 1 and 5 to this Bill amend the ITAA 1997, the ITAA 1936 and the TAA 1953 to improve the integrity of the income tax law for arrangements involving stapled structures and to limit access to tax concessions for foreign investors by increasing the MIT withholding rate on fund payments that are attributable to non-concessional MIT income to 30 per cent — that is, at the rate equal to the top corporate tax rate.

1.27               An amount of a fund payment will be non-concessional MIT income if it is attributable to income that is :

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

1.28               Transitional rules apply to fund payments that are attributable to existing investments. If the transitional rules apply, the existing MIT withholding tax rate of 15 per cent will continue to apply until, broadly :

•        for MIT cross staple arrangement income relating to a facility that is not an economic infrastructure facility — 1 July 2026;

•        for MIT cross staple arrangement income relating to a facility that is an economic infrastructure facility — 1 July 2034;

•        for MIT trading trust income — 1 July 2026;

•        for MIT agricultural income — 1 July 2026; and

•        for MIT residential housing income — 1 October 2027.

Comparison of key features of new law and current law

New law

Current law

MIT withholding tax applies to fund payments made by a MIT to foreign resident members.

For members who are residents of an exchange of information country, to the extent that the fund payment is attributable to non-concessional MIT income, the rate of MIT withholding tax is 30 per cent .

An amount of a fund payment is non-concessional MIT income if it is attributable to income that is:

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

Transitional rules apply to fund payments that are attributable to existing investments. If the transitional rules apply, the existing MIT withholding tax rate of 15 per cent continues to apply until, broadly:

•        for MIT cross staple arrangement income relating to a facility that is not an economic infrastructure facility — 1 July 2026;

•        for MIT cross staple arrangement income relating to a facility that is an economic infrastructure facility — 1 July 2034;

•        for MIT trading trust income — 1 July 2026;

•        for MIT agricultural income — 1 July 2026; and

•        for MIT residential housing income — 1 October 2027.

MIT withholding tax applies to fund payments made by a MIT to foreign resident members.

For members of a MIT who are residents of an exchange of information country, the rate of MIT withholding tax is generally 15 per cent.

 

Detailed explanation of new law

1.29               Schedules 1 and 5 to this Bill amend the ITAA 1997, the ITAA 1936 and the TAA 1953 to improve the integrity of the income tax law for arrangements involving stapled structures and to limit access to tax concessions for foreign investors by increasing the MIT withholding rate on fund payments that are attributable to non-concessional MIT income from 15 per cent to 30 per cent — that is, the rate equal to the top corporate tax rate.

1.30               An amount of a fund payment is non-concessional MIT income if it is attributable to income that is :

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

[Schedule 1, items 11 and 12, section 12-435 in Schedule 1 to the TAA 1953 and the definition of ‘non-concessional MIT income’ in subsection 995-1(1) of the ITAA 1997]

1.31               To the extent that a fund payment is attributable to non-concessional MIT income in an income year, the trustee of a trust that is a withholding MIT, a custodian and some other entities must withhold an amount from the fund payment at a rate of 30 per cent — that is, at the rate equal to the top corporate tax rate. [Schedule 1, items 6 to 8, paragraphs 12-385(3)(a), 12-390(3)(a) and 12-390(6)(a) in Schedule 1 to the TAA 1953]

1.32               The Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018 makes consequential amendments to the Income Tax (Managed Investment Trust Withholding Tax) Act 2008 to specify that the MIT withholding rate on income attributable to non-concessional MIT income is 30 per cent. [Schedule 1 to the Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018, items 1 and 2, the definition of ‘non-concessional MIT income’ in section 2A and paragraph 4(1)(a) of the Income Tax (Managed Investment Trust Withholding Tax) Act 2008]

1.33               If a MIT or a custodian that is a withholding MIT makes a payment to another entity, the MIT or a custodian must notify, or make information available to, that other entity of certain details relating to the payment.

1.34               Consequential amendments ensure that, if the payment is, or is attributable to, non-concessional MIT income, then the details relating to the payment that must be notified by, or made available by, the MIT or custodian includes the extent to which the payment is non-concessional MIT income. [Schedule 1, items 9 and 10, paragraphs 12-385(3)(ab) and 12-395(6)(ab) in Schedule 1 to the TAA 1953]

MIT cross staple arrangement income

1.35               A MIT will have an amount of MIT cross staple arrangement income if, broadly, it derives, receives or makes an amount that is attributable to a cross staple arrangement between an operating entity to an asset entity.

What is an asset entity?

1.36               An asset entity , in relation to an income year, is a trust or a partnership (if it were treated as a trust) that is not covered by subsection 275-10(4) of the ITAA 1997 in relation to the income year. [Schedule 1, items 11 and 12, subsections 12-436(1) and (3) in Schedule 1 to the TAA 1953 and the definition of ‘asset entity’ in subsection 995-1(1) of the ITAA 1997]

1.37               A trust is covered by subsection 275-10(4) of the ITAA 1997 if, broadly:

•        in the case where the trust is a unit trust, the trust is a trading trust for the purposes of Division 6C of Part III of the ITAA 1936; or

•        in the case where the trust is not a unit trust:

-       the trust carries on a trading business (within the meaning of Division 6C of Part III of the ITAA 1936); or

-       the trust controls, or is able to control directly or indirectly, the affairs or operations of another person in respect of the carrying on of a trading business by that other person.

1.38               Therefore, an asset entity includes a unit trust that is not a trading trust. In addition, an asset entity includes other types of trusts or a partnership that, if it were treated like a unit trust, would not be a trading trust.

1.39               In essence, an asset entity is an entity that only derives income from business that is eligible investment business (as defined in section 102M of the ITAA 1936). Eligible investment business is business that consists of, for example, investing in land for the purposes of deriving rent or trading in shares.

What is an operating entity?

1.40               An operating entity , in relation to an income year, is a trust that is covered by subsection 275-10(4) of the ITAA 1997 in relation to the income year. [Schedule 1, items 11 and 12, subsection 12-436(2) in Schedule 1 to the TAA 1953 and the definition of ‘operating entity’ in subsection 995-1(1) of the ITAA 1997]

1.41               An operating entity , in relation to an income year, is also a partnership or company that, if it were treated as a trust, would be covered by subsection 275-10(4) of the ITAA 1997 in relation to the income year. [Schedule 1, item 11, subsections 12-436(2) and (3) in Schedule 1 to the TAA 1953]

1.42               Therefore, unlike an asset entity, an operating entity would be an entity that can derive income from a trading business (as defined in Division 6C of Part III of the ITAA 1936). In essence, any entity that is not an asset entity will be an operating entity.

What is a cross staple arrangement?

1.43               A cross staple arrangement is an arrangement that is entered into by two or more entities (the arrangement entities) if:

•        at least one of the arrangement entities is an asset entity;

•        at least one of the arrangement entities is an operating entity; and

•        the following conditions are satisfied:

-       one or more other entities who are not party to the cross staple arrangement (the external entities) each hold a total participation interest (that is, direct and indirect participation interests) in each arrangement entity (that is, in both the asset entity and the operating entity); and

-       the sum of the total participation interests held by the external entities in each arrangement is 80 per cent or more.

[Schedule 1, items 11 and 12, subsection 12-436(4) in Schedule 1 to the TAA 1953 and the definition of ‘cross staple arrangement’ in subsection 995-1(1) of the ITAA 1997]

1.44               An arrangement is defined in subsection 995-1(1) to mean any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

1.45               In working out the sum of total participation interests held by external entities in each arrangement entity, a particular direct or indirect participation interest held in the arrangement entity is taken into account only once. [Schedule 1, item 11, subsection 12-436(5) in Schedule 1 to the TAA 1953]

Example 1.1: Cross staple arrangement



 

Asset Trust is an asset entity and Op Co is an operating entity.

Investor A holds 30 per cent of the units in Asset Trust and 30 per cent of the shares in Op Co.

Investor B holds 70 per cent of the units in Asset Trust and 70 per cent of the shares in Op Co.

Investor A and B, which are entities that are not parties to the cross staple arrangement, together hold 100 per cent of the participation interests in Asset Trust and Op Co.

Therefore, the lease entered between Asset Trust and Op Co is a cross staple arrangement.

1.46               The total participation interests that an investor holds in another entity is adjusted if:

•        an entity (the test entity) has a total participation interest in two or more entities that entered into the cross staple arrangement; and

•        either:

-       the amount (the lowest participation interest amount) of one of those participation interests falls short of the amount of each of the other participation interests; or

-       the amount (the lowest participation interest amount) of two or more of those participation interests is the same but falls short of the amount of each of the other participation interests.

[Schedule 1, item 11, subsection 12-436(6) in Schedule 1 to the TAA 1953]

1.47               In these circumstances, for the purpose of working out the total participation interests that an investor holds in another entity, the test entity’s total participation interest amount is equal to the lowest participation interest amount. [Schedule 1, item 11, subsection 12-436(7) in Schedule 1 to the TAA 1953]

1.48               This ensures that if external entities have disproportionate interests in the asset entity and operating entity, only the common ownership percentage is counted.

Example 1.2: Cross staple arrangement — total participation interest

Assume the facts are the same as Example 1.1, except that:

•        Investor A holds 40 per cent of the units in Asset Trust and 50 per cent of the shares in Op Co;

•        Investor B holds 60 per cent of the units in Asset Trust and 40 per cent of the shares in Op Co; and

•        Investor C holds no units in Asset Trust and 10 per cent of the shares in Op Co. 

Investor A’s 40 per cent participation interest in Asset Trust falls short of the 50 per cent participation interest in Op Co. Therefore, for the purpose of determining whether a cross staple arrangement exists, Investor A’s 50 per cent participation interest is treated as being equal to the lowest participation interest (that is, 40 per cent).

Similarly, as Investor B’s 40 per cent holding in Op Co falls short of  its 60 per cent holding in Asset Trust, its participation interest is treated as 40 per cent. 

Investor C is treated as holding a nil participation interest because it holds no participation interests in Asset Trust.

Investor A and B are external entities (that is, they are entities that are not parties to the cross staple arrangement) which together hold 80 per cent of the participation interests in Asset Trust and Op Co.

Accordingly the lease entered between Asset Trust and Op Co is a cross staple arrangement.

1.49               A cross staple arrangement that is for the lease of land (and fixtures on the land) between two or more parties would be covered by the definition of a cross staple arrangement. A cross staple financial arrangement, such as a total return swap, is also covered by the definition.

1.50               However, to avoid doubt, equipment will be industrial, commercial or scientific equipment to the extent that an amount paid or credited as consideration for the use of the equipment, or for the right to use the equipment, is not rent from land (including rent from an interest in land or rent from fixtures on land). [Schedule 1, item 15, the definition of ‘industrial, commercial or scientific equipment’ in subsection 6(1) of the ITAA 1936]

1.51               The purpose of this definition is to clarify the income tax law to remove any doubt that rent from land (including rent from an interest in land or rent from fixtures on land) is not a royalty.

What is a stapled entity?

1.52               Each of the entities that have entered into the cross staple arrangement is a stapled entity . [Schedule 1, items 11 and 13, subsection 12-436(8) in Schedule 1 to the TAA 1953 and paragraph (a) of the definition of ‘stapled entity’ in subsection 995-1(1) of the ITAA 1997]

When does a MIT have an amount of MIT cross staple arrangement income?

1.53               A MIT will have an amount of MIT cross staple arrangement income in relation to an income year if:

•        the MIT has an amount of assessable income for that income year;

•        the amount of assessable income is, or is attributable to, an amount that is derived, received or made from a separate entity (the second entity) — the second entity will generally make a payment of the amount (directly or indirectly through, for example, interposed trusts) to the MIT; and

•        the amount of assessable income is not an amount that is excluded from being a fund payment of a MIT — broadly, amounts that are not a fund payment of a MIT include:

-       dividends, interest and royalties;

-       net capital gains in relation to a CGT asset that is not taxable Australian « property » ; and

-       amounts which are not Australian sourced income.

[Schedule 1, item 11, subsection 12-437(1) in Schedule 1 to the TAA 1953]

1.54               Therefore, interest income from a cross staple arrangement (for example, from a cross staple loan) is not MIT cross staple arrangement income.

1.55               An amount will be MIT cross staple arrangement income of a MIT if:

•        the MIT is an asset entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement;

•        the second entity is an operating entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement; and

•        the amount is derived, received or made by the MIT from the second entity — this amount would be an assessable amount to the MIT.

[Schedule 1, item 11, subparagraphs 12-437(2)(a)(i), (b)(i) and (c)(i) in Schedule 1 to the TAA 1953]

1.56               Therefore, where a MIT is a direct party to a cross staple arrangement and, for example, an amount of cross staple rent is paid from an operating entity to the MIT, that amount will be treated as MIT cross staple arrangement income. However, an amount will not be MIT cross staple arrangement income if it is covered by one of the exclusions contained in subsections 12-437(3), (4), (5), (6) or (8).

Example 1.3: Direct cross staple arrangement

Asset Trust and Op Co are stapled entities.

Asset Trust is a MIT that owns a hotel. Asset Trust earns $100,000 of rent from the hotel that it has leased to Op Co (an operating company).

The $100,000 rent received by Asset Trust from Op Co (the second entity) is MIT cross staple arrangement income unless a specific exception applies.

1.57               An amount will also be MIT cross staple arrangement income of a MIT if:

•        the second entity is an asset entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement;

•        another entity (the third entity) is an operating entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement; and

•        the amount is attributable to an amount that is derived, received or made by the second entity from the third entity.

[Schedule 1, item 11, subparagraphs 12-437(2)(a)(ii), (b)(ii) and (c)(ii) in Schedule 1 to the TAA 1953]

1.58               Therefore, where a MIT is not a party to a cross staple arrangement but has an amount of income that is attributable to the arrangement, that amount will be MIT cross staple arrangement income.

1.59               This would occur if the MIT receives a distribution from an asset entity where the net income of the asset entity includes an amount of assessable income in relation to a cross staple arrangement. It would arise, for example, where the MIT is a beneficiary of another trust that is a party to a cross staple arrangement.

1.60               In addition, an amount will be attributable to a cross staple arrangement where there are multiple tiers of flow through entities interposed between the MIT and the second entity (which is the asset entity that is a party to the cross staple arrangement).

Example 1.4: Amount attributable to cross staple arrangement

Assume the facts are the same as Example 1.3, except that:

•        Hold Trust, which is a MIT, owns all of the units in Asset Trust;

•        Asset Trust is not a MIT;

•        Asset Trust, in calculating its net income for the year, has no other assessable income and has deductible expenses of $30,000; and

•        Hold Trust is presently entitled to all of the income from Asset Trust and, for the purposes of calculating its net income for the income year, includes its share of the net income of Asset Trust ($70,000) in its assessable income.

Therefore, the assessable income of Hold Trust ($70,000) is attributable to the cross staple rent that Asset Trust (the second entity) receives from Op Co (the third entity) and is MIT cross staple arrangement income unless a specific exception applies.

1.61               There are four circumstances in which an amount that is attributable to a cross staple arrangement will not be MIT cross staple arrangement income of a MIT. These are:

•        where cross staple rent can be traced to an amount of third party rent from land investment charged by an operating entity;

•        where the income from a cross staple arrangement satisfies the de minimis rule for an asset entity;

•        where the income from a cross staple arrangement is, or is attributable to, rent from an approved economic infrastructure facility; and

•        where the income from a cross staple arrangement is, or is attributable to, a capital gain that arises because an operating entity acquires an asset from the asset entity.

[Schedule 1, item 11, subsections 12-437(3), (4), (5) and (7) in Schedule 1 to the TAA 1953]

The third party rent exception

1.62               An amount that is attributable to a cross staple arrangement will not be MIT cross staple arrangement income of a MIT to the extent that it is attributable to an amount of rent from land investment that is derived, received or made by a stapled entity in relation to the cross staple arrangement from an entity that is not a stapled entity in relation to the cross staple arrangement. [Schedule 1, item 11, subsection 12-437(3) in Schedule 1 to the TAA 1953]

1.63               An amount of rent is rent from land investment if it is derived or received from investments in land (including investments in certain moveable « property » that are specified in subsection 102MB(1) of the ITAA 1936). [Schedule 1, item 12, definition of ‘rent from investment in land’ in subsection 995-1(1) of the ITAA 1997]

1.64               If an operating entity derives a combination of third party income that is rent from land investment and other income, then the amount will be MIT cross staple arrangement income only to the extent that cross staple rent received by the asset entity from the operating entity is not attributable to that third party rent from land investment.

Example 1.5: Amount attributable to cross staple arrangement

Asset Trust owns land and certain ancillary safety equipment, being moveable « property » that is taken to be an investment in land under section 102MB of the ITAA 1936.

Asset Trust leases both the land and equipment in their entirety to Op Co in consideration for payments of rent. This arrangement is a cross staple arrangement entered into by Asset Trust (an asset entity) and Op Co (an operating entity).

Op Co enters into a sub-lease agreement with a third party tenant. Under the terms of this agreement, Op Co also sub-leases safety equipment to the third party tenant. This is to ensure that the tenant can safely access and utilise the land.

Op Co has no other income or expenses (other than the cross staple lease payment).

The rent received by the Asset Trust will not be MIT cross staple arrangement income as it is wholly attributable to rent from land investment (comprising of rent payments for the use of both land and moveable « property » ) that is derived by Op Co (a stapled entity in relation to the cross staple arrangement) from a third party tenant (that is, an entity that is not a stapled entity in relation to the cross staple arrangement).

Example 1.6: Amount attributable to cross staple arrangement

Asset Trust owns commercial « property » (a specialist homewares shopping centre). It leases that commercial « property » to Op Co in consideration for an annual rental payment of $80,000. This arrangement is a cross staple arrangement entered into by Asset Trust (an asset entity) and Op Co (an operating entity) with a cross staple payment of $80,000.

Op Co enters into sub-lease agreements with third party tenants for exclusive possession of retail spaces. Separately, it enters into licence arrangements with respect to common areas for the use of temporary advertising or promotional displays.

Op Co derives:

•        $90,000 in third party rental income from its sub-leases (net of attributable expenses other than the cross-staple rent); and

•        $10,000 from its licence arrangements (net of attributable expenses other than the cross-staple rent).

To determine the amount of income that is attributable to third party rental income, Op Co must reduce the third party rental income by part of the $80,000 cross staple payment on a proportionate basis.

Therefore, because 90 per cent of Op Co’s income is from third party rent, 90 per cent of the cross staple payment is attributable to that amount. Consequently, in relation to the cross staple payment of $80:

•        $72,000 (that is, $80,000 x 90 per cent) is attributable to third party rent and will not be MIT cross staple arrangement income; and

•        $8,000 will be MIT cross staple arrangement income.

The de minimis exception

1.65               An amount from a cross staple arrangement, or that is attributable to a cross staple arrangement, will not be MIT cross staple arrangement income of a MIT to the extent that it is covered by the de minimis exception in section 12-438. [Schedule 1, item 11, subsection 12-437(4) in Schedule 1 to the TAA 1953]

1.66               An amount is covered by the de minimis exception if:

•        the amount is MIT cross staple arrangement income for the income year of an asset entity in relation to a cross staple arrangement; and

•        the MIT cross staple arrangement income of the asset entity for the previous income year did not exceed five per cent of the asset entity’s assessable income (disregarding any net capital gains) for that previous income year.

[Schedule 1, item 11, subsections 12-438(1) to (4) in Schedule 1 to the TAA 1953]

1.67               Therefore, although the MIT is an asset entity in relation to a cross staple arrangement, it may have no cross staple arrangement income because of the operation of the de minimis exception.

1.68               If the asset entity did not exist in the previous income year, the asset entity can work out whether the de minimis exception applies based on reasonable estimates of MIT cross staple arrangement income, assessable income and total assessable income for the current income year. [Schedule 1, item 11, subsection 12-438(5) in Schedule 1 to the TAA 1953]

1.69               In addition, if the asset entity did exist in the previous income year but is not a MIT, the asset entity is treated as a MIT for the purpose of working out whether the de minimis exception applies. [Schedule 1, item 11, subsection 12-438(6) in Schedule 1 to the TAA 1953]

Example 1.7: Application of the de minimis exception

Asset Trust and Op Co are stapled entities. Asset Trust is a MIT.

In the current year, Asset Trust has cross staple rental income from Op Co of $60,000.

In the previous income year, Asset Trust had cross staple rental income from Op Co of $45,000. 

Asset Trust’s total assessable income in the previous year (disregarding any net capital gain) was $1 million. 

For that income year, the percentage of income attributable to cross staple arrangement income was 4.5 per cent of assessable income.

Because Asset Trust’s MIT cross staple arrangement income did not exceed 5 per cent of its assessable income in the previous income year, the de minimis exception will apply so that the amount of cross staple rent ($60,000) will not be MIT cross staple arrangement income of the MIT in the current income year.

Example 1.8: Application of the de minimis exception where MIT receives a distribution from a trust that has a cross staple arrangement

Hold Trust is a MIT that owns all of the units in Asset Trust.

Asset Trust (which is not a MIT) and Op Co are stapled entities in relation to a cross staple lease arrangement. Asset Trust is a second entity mentioned in section 12-437. 

In the 2020-21 income year:

•        Asset Trust received $70,000 of cross staple rental income from Op Co; and

•        Hold Trust, which is presently entitled to all of the income of Asset Trust, includes $70,000 in its assessable income — this amount will be MIT cross staple arrangement income unless the de minimis exception in section 12-438 is satisfied.

As Asset Trust is a second entity in relation to a cross staple arrangement, the de minimis exception is applied to Asset Trust (subsection 12-438(5)), rather than on an aggregate basis for the MIT.

To determine whether the de minimis exception applies to the MIT cross staple arrangement income of Asset Trust, it is necessary to consider the amount of the Asset Trust’s MIT cross staple arrangement income and assessable income for the previous income year.

In the 2019-20 income year:

•        Asset Trust received $60,000 of cross staple rental income from Op Co; and

•        Asset Trust’s total assessable income (disregarding any net capital gains) was $1 million.

Therefore, for the 2019-20 income year, the percentage of MIT cross staple arrangement income for Asset Trust was 6 per cent of its assessable income (disregarding net capital gains).

As Asset Trust exceeded the de minimis exception threshold of 5 per cent in the 2019-20 income year, any MIT cross staple arrangement income for the 2020-21 income year will not be disregarded.

Consequently, when the MIT cross staple arrangement income for the 2020-21 income year flows to a foreign investor through Hold Trust, it will be non-concessional MIT income that is subject to MIT withholding at a rate of 30 per cent. In this regard, it does not matter whether, on an aggregate basis, Hold Trust had less than 5 per cent of its assessable income attributable to MIT cross staple arrangement income in the 2019-20 income year.

T he approved economic infrastructure facility exception

1.70               An amount that is attributable to a cross staple arrangement will not be MIT cross staple arrangement income of a MIT to the extent that it is, or is attributable to, rent from land investment that is:

•        attributable to a facility, or an improvement to a facility; and

•        referable to a time in the income year when the facility, or the improvement to the facility, is covered by the approved economic infrastructure facility exception in section 12-439.

[Schedule 1, item 11, subsection 12-437(5) in Schedule 1 to the TAA 1953]

1.71               The approved economic infrastructure facility exception applies to a facility or to an improvement to a facility. The transitional rule for MIT cross staple arrangement income (which is discussed later in this Chapter) also applies to a facility. The question as to when a collection of assets comprise a facility is considered in the explanation of the operation of that transitional rule.

1.72               The approved economic infrastructure facility exception applies to a facility at a time if:

•        the facility is covered by an approval of the Treasurer that is in force at that time; and

•        that time is no later than the end of the period of 15 years beginning on the day on which an asset that is part of that facility is first put to use.

[Schedule 1, item 11, subsection 12-439(1) in Schedule 1 to the TAA 1953]

1.73               The approved economic infrastructure facility exception also applies to an improvement to a facility at a time if:

•        the improvement to the facility is covered by an approval of the Treasurer that is in force at that time; and

•        that time is no later than the end of the period of 15 years beginning on the day on which an asset that is part of that facility is first put to use after it has been improved under the improvement.

[Schedule 1, item 11, subsection 12-439(2) in Schedule 1 to the TAA 1953]

1.74               This allows approved economic infrastructure projects to be held in a stapled structure and for cross staple rent from land investment to be eligible to access the 15 per cent MIT rate for a period of 15 years from the time when an asset that is part of that facility is first put to use. The facility or an asset that is part of that facility will be first put to use when it becomes operational (even if it does not produce assessable income). At the end of the 15 year period, the cross staple rent from land investment will be MIT cross staple arrangement income. 

1.75               Importantly, to access this concession, the asset entity must satisfy the usual conditions in Division 6C of Part III of the ITAA 1936 which require the investment in the infrastructure facility to be an investment in land for the purpose, or primarily for the purpose, of deriving rent.

1.76               An Australian government agency (other than the Commonwealth) may make an application to the Treasurer in respect of a particular infrastructure facility, or an improvement to an infrastructure facility, specified in the application. [Schedule 1, item 11, subsection 12-439(3) in Schedule 1 to the TAA 1953]

1.77               An Australian government agency is defined in subsection 995-1(1) of the ITAA 1997 to mean:

•        the Commonwealth, a State or a Territory; or

•        an authority of a Commonwealth, a State or a Territory.

1.78               The Treasurer may approve the facility, or the improvement to the facility, specified in the application if the Treasurer is satisfied that the following criteria are met:

•        the facility is an economic infrastructure facility;

•        the estimated capital expenditure on the facility is $500 million or more;

•        the facility is yet to be constructed;

•        the facility will significantly enhance the long-term productive capacity of the economy; and

•        approving the facility is in the national interest.

[Schedule 1, item 11, subsection 12-439(4) in Schedule 1 to the TAA 1953]

1.79               Similarly, the Treasurer may approve the improvement to a facility specified in the application if the Treasurer is satisfied that the following criteria are met:

•        the facility is an economic infrastructure facility;

•        the estimated capital expenditure on the improvement to the facility is $500 million or more;

•        the improvement to the facility is yet to be constructed;

•        the improvement to the facility will significantly enhance the long-term productive capacity of the economy; and

•        approving the improvement to the facility is in the national interest.

[Schedule 1, item 11, subsection 12-439(4) in Schedule 1 to the TAA 1953]

1.80               Economic infrastructure facilities are enduring facilities that support or enable economic activity and improve national productivity in Australia. A facility is an economic infrastructure facility if it is:

•        transport infrastructure;

•        energy infrastructure;

•        communications infrastructure; or

•        water infrastructure.

[Schedule 1, items 11 and 12, subsection 12-439(5) in Schedule 1 to the TAA 1953 and the definition of ‘economic infrastructure facility’ in subsection 995-1(1) of the ITAA 1997]

1.81               Examples of economic infrastructure facilities include:

•        electricity distribution networks;

•        toll road networks; and

•        ports.

1.82               Examples of facilities that would not typically be economic infrastructure include a mining operation and a water facility built for use by a single commercial business.

1.83               The Treasurer’s approval may apply to a new facility or to the substantial improvement of an existing facility.

1.84               In determining whether a facility (or a substantial improvement to a facility) will significantly enhance the long-term productive capacity of the economy, the Treasurer may consider whether:

•        the economic benefits resulting from the facility (or the substantial improvement) outweighs, or will outweigh, the economic costs; and

•        in the opinion of Infrastructure Australia, the facility is nationally significant infrastructure within the meaning of the Infrastructure Australia Act 2008 .

1.85               The Treasurer may also consult with other Commonwealth Government departments and agencies to assess whether a facility (or a substantial improvement to a facility) will significantly enhance the long-term productive capacity of the economy.

Example 1.9: Substantial improvement to a facility

An application is made by a State Government to the Treasurer for the approved economic infrastructure facility exception.

The application relates to a proposed expansion of an existing port facility which is projected to result in:

•        a significant increase in the port’s capacity; and

•        a significant extension of the life of the port.

The estimated capital expenditure on the substantial improvement is $650 million.

The proposed $650 million expansion of the port facility relates to a substantial improvement of an economic infrastructure asset. Therefore, the Treasurer may approve the proposed substantial improvement of the facility if the Treasurer is satisfied it meets the relevant criteria.

1.86               The Treasurer’s approval of an economic infrastructure facility, or the improvement to an economic infrastructure facility:

•        must be in writing;

•        must specify the facility, or the improvement, that is approved;

•        must specify the date on which the approval comes into force; and

•        may contain any other information the Treasurer considers appropriate.

[Schedule 1, item 11, subsection 12-439(6) in Schedule 1 to the TAA 1953]

1.87               The Treasurer may publish an approval of a particular facility, or an improvement to a facility, in any way that the Treasurer considers appropriate. [Schedule 1, item 11, subsection 12-439(7) in Schedule 1 to the TAA 1953]

1.88               If the Treasurer decides not to approve a facility, or an improvement to a facility, the Treasurer must notify the applicant of the decision in writing as soon as practicable after making the decision. [Schedule 1, item 11, subsection 12-439(8) in Schedule 1 to the TAA 1953]

1.89               The Treasurer’s decision to approve a facility, or an improvement to a facility, as an approved economic infrastructure facility is excluded from the operation of the Administrative Decisions (Judicial Review) Act 1977 and therefore is not reviewable on its merits. [Schedule 1, item 14, paragraph (gaaa) of the Administrative Decisions (Judicial Review) Act 1977]

1.90               The Treasurer’s decision is not reviewable on its merits because key factors that must be taken into account when making a decision include whether:

•        the facility will significantly enhance the long-term productive capacity of the economy; and

•        approving the facility is in the national interest.

1.91               Consideration of these factors involves complex questions of government policy that can have broad ranging implications for persons other than those immediately affected by the decision. Therefore, it is not appropriate for the decision to be subject to merits under the Administrative Decisions (Judicial Review) Act 1977 .

1.92               However, the Treasurer’s decision will remain subject to judicial review under section 39B of the Judiciary Act 1903.

1.93               The approved economic infrastructure facility exception applies only in respect of MIT cross staple arrangement income that is attributable to rent from land investment arising from cross staple arrangements. It does not apply to other cross staple arrangements (for example, a total return swap) entered into in respect of the infrastructure facility or to MIT trading trust income.

1.94               In addition, although a facility may be an economic infrastructure facility, the facility would need to include an interest in land that is capable of giving rise to rent in order to benefit from the exception.

1.95               New section 25-115 of the ITAA 1997 provides a specific deduction to an operating entity that has entered into a cross staple arrangement in respect of an approved infrastructure facility for which it pays rent to the asset entity for the duration of the concession period, provided certain conditions are met.

1.96               In this regard, an entity that is an operating entity in relation to the cross staple arrangement can deduct an amount, for an income year, of rent from land investment if:

•        another entity derives, receives or makes an amount of rent from land investment from the operating entity in the income year;

•        the rent from land investment is derived or received on or after 27 March 2018;

•        the cross staple arrangement was entered into in relation to:

-       a facility that is an approved economic infrastructure facility at a time in the income year; or

-       an improvement to a facility, where the improvement is an approved economic infrastructure facility, at a time in the income year;  

•        the other entity is an asset entity in relation to the cross staple arrangement;

•        apart from subsection 25-115(1), the operating entity could otherwise deduct the amount under the income tax law;

•        the amount is excepted MIT CSA income of the asset entity for the income year; and

•        each entity that is a stapled entity in relation to the cross staple arrangement has made a choice in relation to the cross staple arrangement.

[Schedule 1, item 2, subsection 25-115(1) of the ITAA 1997]

1.97               An amount is excepted MIT CSA income of a MIT in relation to an income year if the amount would be MIT cross staple arrangement income of the MIT but for:

•        the approved economic infrastructure facility exception; or

•        the MIT cross staple arrangement income transitional rule.

[Schedule 1, items 11 and 12, section 12-442 in Schedule 1 to the TAA 1953 and the definition of ‘excepted MIT CSA income in subsection 995-1(1) of the ITAA 1997]

1.98               If the asset entity is not a MIT then, for the purposes of working out whether an amount is excepted MIT CSA income of the asset entity for the income year under paragraph 25-115(1)(e) of the ITAA 1997, the asset entity is taken to be a MIT in relation to the income year. [Schedule 1, item 2, subsection 25-115(2) of the ITAA 1997]

1.99               A choice that is made under subsection 25-115(3) of the ITAA 1997:

•        must be made by the entity in the approved form before the start of the income year in which the asset is first put to use or such later time as is allowed by the Commissioner;

•        must be given by the entity to the Commissioner within 60 days after the entity makes the choice; and

•        is irrevocable.

[Schedule 1, item 2, subsections 25-115(3) and (4) of the ITAA 1997]

1.100           The choice will only need to be made by the entities who are the parties to the cross staple arrangement in relation to the approved economic infrastructure facility that gives rise to rent from land investment. This will be the operating entity which incurs the rent and the asset entity which derives the rent.

1.101           Entities that make this choice will be subject to additional integrity rules to safeguard against aggressive cross-staple pricing arrangements during the concession period. The integrity rules apply if a MIT derives, receives or makes an amount (directly or indirectly) that is excepted MIT CSA income.

1.102           An amount is excepted MIT CSA income of a MIT in relation to an income year if the amount would be MIT cross staple arrangement income of the MIT but for, so far as is relevant, the approved economic infrastructure facility exception.

1.103           The integrity rules:

•        extend the scope of the non-arm’s length income rule; and

•        apply a concessional cross staple rent cap.

1.104           As amounts that are covered by the transitional rules for MIT cross staple arrangement income are also excepted MIT CSA income, the operation of the integrity rules is explained later in this Chapter.

1.105           The general anti-avoidance rule in the income tax law (Part IVA of the ITAA 1936) applies only if a taxpayer has obtained a tax benefit in relation to a scheme. However, if a deduction is allowable to a taxpayer as a result of the making of a choice under the income tax law, then the taxpayer is not taken to have obtained a tax benefit in relation to the allowance of the deduction (subparagraph 177C(2)(b)(i) of ITAA 1936).

1.106           Consequently, if a choice is made under subsection 25-115(2) of the ITAA 1997 then, for the purposes of the general anti-avoidance rule, the operating entity will not be taken to have obtained a tax benefit in relation to the allowance of the deduction for the cross staple rental payment to the asset entity.

1.107           Paragraph 25-115(1)(e) of the ITAA 1997 limits the effect of this choice to deductions for payments that give rise to excepted MIT CSA income of the asset entity. Deductions that give rise to other forms of income of an asset entity are not affected by this choice.

The capital gains exception

1.108           An amount that is attributable to a cross staple arrangement will not be MIT cross staple arrangement income of a MIT to the extent that it is attributable to a capital gain if:

•        the capital gain is made in relation to the income year by an asset entity because an operating entity acquires an asset from the asset entity; and

•        the asset entity and the operating entity are stapled entities in relation to the cross staple arrangement.

[Schedule 1, item 11, subsections 12-437(6) and (7) in Schedule 1 to the TAA 1953]

Example 1.10: MIT cross staple arrangement income that is attributable to a capital gain

Asset Trust and Op Co are stapled entities.

Asset Trust is a MIT that owns a building that has been held for rental purposes.

Asset Trust sells the building to Op Co for $10 million (at market value).

The capital gain made by Asset Trust on disposal of the building to Op Co (the second entity) will not be MIT cross staple arrangement income because of the capital gains exception.

MIT cross staple arrangement income — Transitional rules

1.109           The amendments generally apply to a fund payment made by a MIT in relation to an income year if:

•        the fund payment is made on or after 1 July 2019; and

•        the income year is the 2019-20 income year or a later income year.

1.110           However, transitional rules apply in relation to MIT cross staple arrangement income that is attributable to a facility that existed or is sufficiently committed to at the time of announcement of the measure.

1.111           These transitional rules will also cover future expansions and enhancements where assets are added to an existing facility to improve or extend its functionality. However, an assessment will need to be made on a case by case basis as to whether the additions or enhancements form part of the existing facility or are a new facility. If the new assets are a new facility in their own right, that new facility will not benefit from the transition rules.

1.112           The MIT cross staple arrangement income transitional rules will apply if:

•        before 27 March 2018, an Australian government agency:

-       decided to approve the acquisition, creation or lease of a facility;

-       publicly announced that decision; and

-       took significant preparatory steps to implement that decision;

•        either:

-       a cross staple arrangement was entered into in relation to the facility before 27 March 2018; or

-       it was reasonable on 27 March 2018 to conclude that a cross staple arrangement will be entered into in relation to the facility;

•        all the entities that are stapled entities in relation to the cross staple arrangement already existed before 27 March 2018; and

•        each entity that is a stapled entity in relation to the cross staple arrangement has made a choice to apply the transitional rule.

[Schedule 1, item 11, subsection 12-440(1) in Schedule 1 to the TAA 1953]

1.113           The MIT cross staple arrangement income transitional rules will also apply if:

•        either:

-       an entity entered into a contract before 27 March 2018 for the acquisition, creation or lease of a facility; or

-       an entity owns, or is the lessee of, a facility at a time before 27 March 2018;

•        either:

-       a cross staple arrangement was entered into by that entity in relation to the facility before 27 March 2018; or

-       it was reasonable on 27 March 2018 to conclude that a cross staple arrangement will be entered into by that entity in relation to the facility;

•        all the entities that are stapled entities in relation to the cross staple arrangement already existed before 27 March 2018; and

•        each entity that is a stapled entity in relation to the cross staple arrangement has made a choice to apply the transitional rule.

[Schedule 1, item 11, subsection 12-440(2) in Schedule 1 to the TAA 1953]

1.114           A contract to acquire land will not be a contract for the acquisition of a facility, as land is not a facility in and of itself.

1.115           A choice that is made under subsection 12-440(1) or (2):

•        must be made by the entity in the approved form no later than 30 June 2019 or such later time as is allowed by the Commissioner;

•        must be given by the entity to the Commissioner within 60 days after the entity makes the choice; and

•        is irrevocable.

[Schedule 1, item 11, subsections 12-440(5) and (6) in Schedule 1 to the TAA 1953]

1.116           The choice must be made by the entities who are the parties to the cross staple arrangement giving rise to rent from land investment. This will generally be the operating entity which incurs the rent and the asset entity which derives the rent.

Example 1.11: Is an option a contract for the acquisition of a facility?

An entity entered into a call option to purchase an infrastructure facility before 27 March 2018. The call option provides the entity with an option, but not the obligation, to purchase the infrastructure facility.

The option is valid until 30 June 2018, but had not been exercised at 27 March 2018. The holder of the option exercised their rights to acquire the infrastructure facility on 1 June 2018 and the infrastructure facility became the subject of a cross staple lease. 

The option agreement is not a contract for the acquisition of the infrastructure facility. 

The transitional rules will not apply to MIT cross staple arrangement income attributable to the infrastructure facility.

What is a facility?

1.117           A facility is a collection of assets that are connected and together perform a particular function such as, for example, an infrastructure facility or a « property » facility.

1.118           In determining whether a collection of assets together comprise a facility, regard should be had to: 

•        whether the assets are functionally interconnected;

•        whether the assets give rise to a separately identifiable revenue stream;

•        the legal rights of the parties in respect of the assets — such as:

-       the scope of any existing and proposed lease agreement;

-       the applicable regulatory framework; and

-       any applicable licence or concession arrangements;

•        whether the financial viability of assets that existed at the transition time are dependent on the expansions or enhancements that will occur to the facility after the transition time; and

•        any other factors that are relevant in the circumstances of a particular case.

1.119           The question as to whether a collection of assets comprise a facility must be determined taking into account all of the facts and circumstances of a particular case.

1.120           The list of factors above provides guidance as to matters that should be considered in determining whether a collection of assets together comprise a facility. None of the factors are determinative. It is possible that in some cases one or more of the factors may not be present or do not assist in the relevant determination.

Amount will not be MIT cross staple arrangement income

1.121           If the MIT cross staple arrangement income transitional rules apply to a MIT, an amount derived, received or made by the MIT will not be MIT cross staple arrangement income of the MIT if:

•        the amount is, or is attributable to, an amount derived, received or made from another entity (the second entity);

•        the amount relates to an asset that is part of the facility;

•        the second entity is a stapled entity in relation to the cross staple arrangement;

•        either:

-       if the MIT is an asset entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement — the amount is rent from land investment paid from an operating entity to the MIT; or

-       if the second entity is an asset entity in relation to the income year and is a stapled entity in relation to the cross staple arrangement — the amount is attributable to rent from land investment paid from an operating entity to the second entity; and

•        the time when the amount was derived, received or made by the MIT meets the timing requirements in subsection 12-440(4) in Schedule 1 to the TAA 1953.

[Schedule 1, item 11, subsection 12-440(3) in Schedule 1 to the TAA 1953]

1.122           The renewal of a lease agreement, covering the same facility and between the same parties, during the applicable transitional period would not be expected to create a new cross staple arrangement.

Deduction for cross staple arrangement payments

1.123           If the MIT cross staple arrangement income transitional rules apply, an entity that is an operating entity in relation to the cross staple arrangement can deduct, for an income year, an amount of rent from investment in land if:

•        another entity derives or receives the amount of rent from investment in land from the operating entity at a time that:

-       is in the income year;

-       is on or after 27 March 2018; and

-       meets the timing requirements in subsection 12-440(4) in Schedule 1 to the TAA 1953;

•        the other entity is an asset entity in relation to the cross staple arrangement; and

•        apart from subsection 12-440(2) in Schedule 1 to the TAA 1953, the operating entity could otherwise deduct the amount of rent from investment in land under the income tax law; and

•        the amount is excepted MIT CSA income of the asset entity for the income year.

[Schedule 1, item 2, subsections 25-120(1) and (2) of the ITAA 1997]

1.124           If the asset entity is not a MIT then, for the purposes of working out whether an amount is excepted MIT CSA income of the asset entity for the income year under paragraph 25-120(2)(d) of the ITAA 1997, the asset entity is taken to be a MIT in relation to the income year. [Schedule 1, item 2, subsection 25-115(2) of the ITAA 1997]

1.125           The general anti-avoidance rule in the income tax law (Part IVA of the ITAA 1936) applies only if a taxpayer has obtained a tax benefit in relation to a scheme. However, if a deduction is allowable to a taxpayer as a result of the making of a choice under the income tax law, then the taxpayer is not taken to have obtained a tax benefit in relation to the allowance of the deduction (subparagraph 177C(2)(b)(i) of ITAA 1936).

1.126           Consequently, if a choice is made under section 12-440 in Schedule 1 to the TAA 1953 then, for the purposes of the general anti-avoidance rule, the operating entity will not be taken to have obtained a tax benefit in relation to the allowance of the deduction for the cross staple rental payment to the asset entity.

1.127           Paragraph 25-120(2)(d) of the ITAA 1997limits the effect of this choice to deductions for payments that give rise to excepted MIT CSA income of the asset entity. Deductions that give rise to other forms of income of an asset entity are not affected by this choice

Timing requirements

1.128           Where the facility to which the cross staple arrangement relates is not an economic infrastructure facility, the timing requirements are met if the time is both:

•        before 1 July 2031; and

•        before the later of:

-       1 July 2026; and

-       the end of the 7 year period beginning on the day upon which an asset that is a part of the facility is first put to use for the purpose of producing assessable income.

[Schedule 1, item 11, paragraph 12-440(4)(a) in Schedule 1 to the TAA 1953]

1.129           Where the facility to which the cross staple arrangement relates is an economic infrastructure facility, the timing requirements are met if the time is both:

•        before 1 July 2039; and

•        before the later of:

-       1 July 2034; and

-       the end of the 15 year period beginning on the day upon which an asset that is a part of the facility is first put to use for the purpose of producing assessable income.

[Schedule 1, item 11, paragraph 12-440(4)(b) in Schedule 1 to the TAA 1953]

1.130           Therefore, if the facility that qualifies under the MIT cross staple arrangement income transitional rules is an existing facility that is already in use and is currently producing income, the transitional rules apply to an amount that is derived, received or made before:

•        if the facility is an economic infrastructure facility — 1 July 2034;

•        otherwise — 1 July 2026.

1.131           If the facility that qualifies under the MIT cross staple arrangement income transitional rules is currently being constructed, or construction of the facility has not yet commenced, the transitional rules will apply to an amount that is derived, received or made after the time that an asset that is a part of the facility is first put to use and starts producing assessable income and:

•        if the facility is an economic infrastructure facility — before the earlier of:

-       1 July 2039; and

-       the end of the 15 year period beginning on the day upon which an asset that is a part of the facility is first put to use for the purpose of producing assessable income;

•        otherwise — before the earlier of:

-       1 July 2031; and

-       the end of the 7 year period beginning on the day upon which an asset that is a part of the facility is first put to use for the purpose of producing assessable income.

Examples of the operation of the MIT cross staple arrangement income transitional rules

Example 1.12: Enhancement to an existing, non-income producing facility

In June 2017, stapled entities entered into a contract with the State Government to acquire and expand an existing un-tolled public highway.

The arrangement involved:

•        the asset entity acquiring a long term lease from the State Government over the highway; and

•        the asset entity sub-leasing the highway to the operating entity which runs the toll road business.

In July 2025, the expansion is completed and the toll road becomes operational and starts to earn assessable income.

The expansion is an enhancement to the existing facility because:

•        the expansion is functionally connected to the existing un-tolled road;

•        the revenue stream generated from the enhancement to the road is not separately identifiable from the existing road; and

•        the legal arrangements support this outcome.

As at 27 March 2018, the facility (the un-tolled road) is an existing economic infrastructure facility that has never been used to produce assessable income.

As a result, the transitional period for the facility will:

•        commence on 1 July 2025; and

•        cease on 1 July 2039 — as this is the earlier of the date listed in paragraph 12-440(4)(b) in Schedule 1 to the TAA 1953 and the end of the period of 15 years beginning on the day on which the toll road is first put to use for the purpose of producing assessable income.

Example 1.13: Enhancements to an existing income producing facility

Prior to and on 27 March 2018:

•        Electricity Network Trust (Asset Trust) and Electricity Network Co (Operating Entity) are parties to a cross staple arrangement;

•        Asset Trust has a leasehold interest in land on which there is an existing electricity network; and

•        Operating Entity:

-       leases that land from Asset Trust and operates a business of providing electricity, in accordance with a project deed with the State Government; and

-       holds certain other tangible assets that are required to operate the electricity network.

The project deed requires Operating Entity to deliver services under an electricity licence to a set standard and to a set geographical area. The project deed does not specify the enhancements to the network that may be required to satisfy legal requirements under the project deed. The total revenue that can be generated from the electricity network is regulated.

The electricity network is an economic infrastructure facility that:

•        existed before 27 March 2018;

•        was held in a cross staple arrangement; and

•        has previously been used to produce assessable income.

As a result, the transitional period will commence on 1 July 2019 and end on 1 July 2034.

In 2025, the State Government announces the development of a new suburb, and construction commences. Asset Trust incurs costs of expanding the existing electricity network to the new suburb (which is within the geographical area to which Operating Entity is required to deliver services under its electricity licence).

Under the arrangement between the Asset Trust and Operating Entity, the rent that Asset Trust charges to Operating Entity is calculated by reference to the value of assets that are the subject of the cross staple lease (which includes the value of any enhancements).

The new assets are functionally interconnected to the existing electricity network and are built to satisfy obligations that are inherently linked to the delivery of the services provided by the existing network. The existing facility and the expansion are subject to the same regulatory regime. Therefore, network connections to the new suburb are enhancements to the existing electricity network facility.

Cross staple rent paid in respect of the extension will be able to access the transitional treatment until 1 July 2034.

Example 1.14: Enhancement of a facility

Hotel Asset Trust is party to a cross staple arrangement that includes Hotel Operating Co. Hotel Asset Trust owns a single building that has approval to operate as a hotel. Hotel Operating Co leases the hotel and has been operating a hotel business since early 2016.

The facility is eligible for a seven year transitional period, commencing on 1 July 2019 and ending on 1 July 2026. 

In January 2020, the Trustee of Hotel Asset Trust and Board of Hotel Operating Co approved an expansion to the existing building to add four new floors. Hotel Operating Co intends to market the new floors as the new ‘executive wing’ of the Hotel once the expansion is complete. The executive wing is expected to become operational in late 2020.

The new floors are an enhancement to the existing facility that has previously been used to produce assessable income. Therefore, the rent charged on the premium wing will not be treated as MIT cross staple arrangement income until 1 July 2026.

Example 1.15: Application of transitional arrangements to a facility contracted before 27 March 2018

In May 2017, the Trustee of Hotel Asset Trust and the Board of Hotel Operating Co approved plans to add a commercial car park adjacent to the Hotel on the same block of land.

The commercial car park is separate to the car park that the hotel has for its guests and will be available for use by the public for a fee.

The car park will not be functionally interconnected with the operation of the hotel facility. The revenue stream arising from the car park will be separately identifiable.

Before 27 March 2018, Hotel Operating Co had entered into a contract with Builder Co to build the car park. Documents considered by the Trustee and the Board outline that the car park, once constructed, would be operated by Hotel Operating Co through a cross staple arrangement with the Hotel Asset Trust.

The commercial car park is a separate facility to the hotel and a new facility in relation to which a cross staple arrangement will be entered into. The commercial car park is built and first put to use for the purpose of producing assessable income on 1 January 2020.

As the facility was contracted for before 27 March 2018, transitional treatment will apply for a period of seven years, commencing on 1 January 2020.

Example 1.16: Non-concessional MIT income for a new facility

In May 2017, the Trustee of Hotel Asset Trust and the Board of Hotel Operating Co considered plans to build a new hotel adjacent to the existing hotel (on the same block of land).

In June 2018, the Trustee enters into a contract with Builder Co to build the new hotel and enters into a cross staple arrangement with Hotel Operating Co in relation to the new building.

The operation of the new hotel facility will not be functionally interconnected with the operation of the existing hotel facility. The revenue stream arising from the new hotel facility will be separately identifiable.

While the new hotel is located on the same block of land as the existing hotel, it is considered a separate and new facility, rather than an enhancement to the existing hotel facility.

As no contracts were entered into for this new facility as at 27 March 2018, any cross staple rent relating to the hotel will be treated as MIT cross staple arrangement income — that is, it will not receive the benefit of the transitional rule.

MIT cross staple arrangement income — Integrity rules for excepted MIT CSA income

1.132           Integrity rules apply if a MIT derives, receives or makes an amount (directly or indirectly) that is excepted MIT CSA income.

1.133           The integrity rules will:

•        extend the scope of the non-arm’s length income rule; and

•        apply a concessional cross staple rent cap.

1.134           If the facility that gives rise to the excepted MIT CSA income is not an economic infrastructure facility (and therefore benefits from the seven year MIT cross staple arrangement income transitional rule), only the non-arm’s length income rule will apply to the facility.

1.135           If the facility that gives rise to the excepted MIT CSA income is an economic infrastructure facility (and therefore benefits from the approved economic infrastructure facility exception or the 15 year MIT cross staple arrangement income transitional rule), both the non-arm’s length income rule and the concessional cross staple rent cap will apply to the facility.

MIT cross staple arrangement income — Extension to the non-arm’s length income rule

1.136           The non-arm’s length income rule in section 275-610 of the ITAA 1997 operates to treat an amount of ordinary or statutory income of a MIT as non-arm’s length income if:

•        the amount is derived from a scheme where the parties were not dealing with each other at arm’s length;

•        the amount exceeds the amount the entity might have derived if those parties had been dealing with each other at arm’s length; and

•        the amount is not a particular type of distribution.

1.137           The Commissioner must make a determination that an amount is non-arm’s length income. If a determination is made, the trustee of the MIT is liable to pay tax on the amount at the top corporate tax rate (that is, 30 per cent).

1.138           The non-arm’s length income rule provides an appropriate safeguard against aggressive cross staple rent pricing for sectors that have readily available data on comparable Australian third party market transactions.

1.139           Therefore, the Commissioner will be able to make a determination to apply the non-arm’s length income rule to a MIT if the amount of ordinary or statutory income is excepted MIT CSA income (regardless of whether or not the MIT is a party to the scheme that gave rise to the non-arm’s length income). [Schedule 1, items 3 and 4, subsections 275-610(1A) and 275-615(1A) of the ITAA 1997]

1.140           If the Commissioner makes a determination to apply the non-arm’s length income rule to a MIT, then the trustee of the MIT is liable to pay tax on the amount at the top corporate tax rate — that is, 30 per cent (subsection 275-605(2) of the ITAA 1997).

1.141           In addition, the net income of the MIT, or the assessable income of a MIT that is an AMIT, is reduced by the amount of the non-arm’s length income (subsections 275-605(3) to (5) of the ITAA 1997). This ensures that the non-arm’s length income is:

•        not included in a fund payment made by the MIT that is subject to MIT withholding tax; and

•        not included in the assessable income of Australian investors under Division 6 of Part III of the ITAA 1936.

MIT cross staple arrangement income — Concessional cross staple rent cap integrity rule

1.142           The concessional cross staple rent cap will apply to a MIT only if:

•        the MIT derives, receives or makes excepted MIT CSA income and the facility that gives rise to the excepted MIT CSA income is an economic infrastructure facility that benefits from:

-       the approved economic infrastructure facility exception; or

-       the 15 year MIT cross staple arrangement income transitional rule; and

•        the amount of excepted MIT CSA income is, or is attributable to, rent from land investment under a cross staple lease entered into by the asset entity and the operating entity that are parties to the cross staple arrangement.

[Schedule 1, item 11, subsection 12-441(1) in Schedule 1 to the TAA 1953]

1.143           The amount of the concessional cross staple rent cap will depend on whether or not, at the transition date (27 March 2018), the cross staple lease is an existing lease with an established method for working out the amount of the rent (including a method that specifies an amount of rent).

1.144           If the relevant asset entity is not a MIT, then the relevant asset entity is taken to be a MIT for the purpose of working out whether its excepted MIT CSA income exceeds the amount of its concessional cross staple rent cap under section 12-441 in Schedule 1 to the TAA 1953. [Schedule 1, item 11, subsection 12-441(3) in Schedule 1 to the TAA 1953]

1.145           This will ensure the cap is worked out at the asset entity level even where the asset entity is not a MIT (with the consequences of breaching the cap at the asset entity level flowing up to the MIT and its investors).

Amount of the cap — existing lease with an established rent method

1.146           An asset entity that has an existing lease arrangement in place with a method to determine the amount of the rent (including a method that specifies an amount of rent) agreed to between the asset entity and operating entity can continue to charge rent under their existing arrangements for the duration of the transition period and remain compliant with the concessional cross staple rent cap.

1.147           The amount of the cap in relation to a cross staple lease is worked out based on the existing amount of rent, or an existing method for working out the amount of the rent, if:

•        the amount is excepted MIT CSA income because the 15 year MIT cross staple arrangement income transitional rule applies;

•        the cross staple lease was entered into before 27 March 2018;

•        the cross staple lease, or any associated documents (such as a rental agreement), that existed before 27 March 2018 specified:

-       the amount of annual rent under the lease; or

-       an objective method for determining the amount of annual rent under the lease which is set out in the cross staple lease or in the associated documents.

[Schedule 1, item 11, subsection 12-443(1) in Schedule 1 to the TAA 1953]

1.148           If a method for determining the amount of annual rent under the lease is set out in the cross staple lease or in the associated documents, then the amount of the concessional cross staple rent cap for an income year of the MIT is the amount of annual rent determined for the income year in the method specified in the lease agreement and/or associated documents. [Schedule 1, items 11 and 12, subsection 12-443(2) in Schedule 1 to the TAA 1953 and the definition of ‘concessional cross staple rent cap’ in subsection 995-1(1) of the ITAA 1997]

1.149           In this regard, the cross staple lease or the associated documents must set out the method for determining the amount of annual rent in an objective manner and be in existence prior to 27 March 2018. 

1.150           It is a question of fact as to whether a fully documented objective method exists. In determining this question, regard must be had to both the lease agreement and any other associated documents that support the calculation of rent under the lease.

1.151           It is not necessary for the method to be stipulated in the lease agreement itself. For example, the lease agreement may specify a fixed amount of rent but there may be other documents which evidence the method which is the basis for the calculation in the lease agreement.  

1.152           In order to establish that there is a method that is set out in the documents, the method must be objective and sufficiently prescriptive so that the calculation of the rental charge relies upon objectively discernible information, and produces a result that would be the same for any reasonable person applying it.

1.153           Examples of circumstances where an objective method may exist in documentation prior to 27 March 2018 are as follows.

•        The lease agreement and/or associated documents provided a formula for the calculation of rent based on a percentage of the regulated asset base. The method is the approach in the formula.

•        The lease agreement and/or associated documents provided for rent to be charged as a percentage of the gross turnover of the operating entity. The method is the percentage of gross turnover that was specified.

•        A lease agreement specifies that the rent will be set at a market rate of rent. At the commencement of the lease, the parties sought a transfer pricing report prepared by an independent expert on 1 July 2017. The report’s conclusions are based on a comparison to rates of rental return on certain assets in the industrial « property » sector. The report provided a data set of comparables and a rent pricing range based on the data set concluding that the midpoint of the range is an appropriate rent yield to apply to the accounting book value of the leased assets. The asset entity and operating entity agree this will be the method by which market rent will be ascertained for that year. The method is the midpoint of the range determined in accordance with the approach adopted in the transfer pricing report to determine the arm’s length rent.

•        The lease agreement prescribes a method comprising five factors to which regard may be had in annual rent reviews. Rent has always been calculated as a set per cent of gross revenue, pursuant to a sub-lease. The way in which the five factors in the sub-lease should be taken into account to determine the set percentage of the gross revenue is set out in the rent notice for the income year ended 30 June 2017. The method is based on the manner in which a range of set factors are applied to determine the amount of the rent. 

•        The lease agreement specifies that the amount of rent is to be calculated based on a percentage of gross turnover of the operating entity and provides for a market rent review every three years. Associated documents show that the method for determining the rent is based on a split of the profit between the asset entity and operating entity (that is, to ensure that both the asset entity and operating entity receive an equal rate of return on their investment) and that the percentage of turnover set in the lease as a proxy to achieve this outcome. The method is the profit split.

1.154           An objective method would not exist, for example, if the lease agreement provided for the rent to be determined at the discretion of the trustee or based on agreement between the trustee and the operating entity.

Example 1.17: Existing lease with method for calculating rent agreed to prior to 27 March 2018

Asset Trust and Op Co entered into a cross staple lease arrangement, with effect from 1 July 2015, over an economic infrastructure facility.

Asset Trust and Op Co are eligible to apply the 15 year MIT cross staple arrangement income transitional rule to the rent earned by Asset Trust on the economic infrastructure facility.

Before 27 March 2018, Asset Trust and Op Co had entered into a lease agreement setting out the terms of the lease. The lease agreement has a lease payment schedule covering the 2017-18 and 2018-19 income years (the covered income years). The payment schedule denotes a fixed dollar amount of lease payments in each of the covered income years.

There is documentary evidence that the method used to determine the rent in the payment schedule was to:

•        adopt the rental yield in a transfer pricing report prepared by an independent expert on 1 July 2017, which concluded that the rent for the covered income years should be determined based on a midpoint of a range of comparable returns for certain leased assets in the industrial « property » sector; and

•        apply that yield to the opening book value of the economic infrastructure facility (that is, the leased assets) for the year.

Because the amounts specified in the lease agreement were determined based on an objective method, Asset Trust would be able to use that objective method to determine its concessional cross staple rent cap.

Therefore, the concessional cross staple rent cap will be based on the midpoint of the range of current market returns on the assets in the industrial « property » sector and the opening accounting book value of the leased assets in the relevant year throughout the transition period.  

1.155           If the cross staple lease and any associated documents specify the amount of annual rent under the lease but do not set out a method for determining that amount, then the amount of the concessional cross staple rent cap for an income year of the MIT is:

•        for an income year where the lease, or the associated documents, specify the amount of annual rent for the corresponding year of the lease — the amount of annual rent specified in the lease for that corresponding year; or

•        for an income year where that amount is not so specified — that annual amount in relation to the most recent year of the lease for which an amount is so specified indexed annually by the All Groups Consumer Price Index (as set out in Subdivision 960-M of the ITAA 1997).

[Schedule 1, items 5, 11 and 12, subsection 12-443(3) in Schedule 1 to the TAA 1953; section 960-265 and the definition of ‘concessional cross staple rent cap’ in subsection 995-1(1) of the ITAA 1997]

1.156           For these purposes, an income year and a year of the lease correspond to each other if both of those years end:

•        after a particular 27 March; and

•        on or before the next 27 March.

[Schedule 1, item 11, subsection 12-443(4) in Schedule 1 to the TAA 1953]

Example 1.18: Existing lease with specified amount of rent agreed to prior to 27 March 2018

Assume the facts are the same as Example 1.17, except that the lease agreement merely states that the parties will meet periodically to agree on a rental amount.

Prior to 27 March 2018, it was determined that, for the income year ending 30 June 2018, Op Co would pay rent of $10 million to Asset Trust. There are no associated documents which outline an objective method that was used to determine the amount of the rent. 

The concessional cross staple rent cap for income years starting on or after 1 July 2019 will be set at $10 million (the rent for the income year ending 30 June 2018) and will be indexed annually by the All Groups Consumer Price Index (as set out in Subdivision 960-M of the ITAA 1997).

Example 1.19: Existing lease with specified amount of rent agreed to prior to 27 March 2018

Assume the facts are the same as Example 1.18, except it was determined under the lease agreement that:

•        for the income year ending 30 June 2018, Op Co would pay rent of $10 million to Asset Trust; and

•        for the income year for the income year ending 30 June 2019, Op Co would pay rent of $10.2 million to Asset Trust.

For later income years, no amount is specified under the lease or the associated documents. In addition, there are no associated documents which outline an objective method which was used to determine the amount of the rent.

The concessional cross staple rent cap for the 2019-20 income year will be set at $10.2 million (the rent for the income year ending 30 June 2019).

The concessional cross staple rent cap for income years starting on or after 1 July 2020 will be set at $10.2 million (the rent for the income year ending 30 June 2019) and will be indexed annually by the All Groups Consumer Price Index (as set out in Subdivision 960-M of the ITAA 1997).

Amount of the cap — no existing lease with established rent method

1.157           The amount of the concessional cross staple rent cap is worked out differently if the amount is excepted MIT CSA income because:

•        the approved economic infrastructure facility exception applies; or

•        the 15 year MIT cross staple arrangement income transitional rule applies and section 12-443 in Schedule 1 to the TAA 1953 does not apply — that is, broadly, the cross staple lease and any associated documents do not, before 27 March 2018, set out a method to determine the amount of the rent (including a method that specifies an amount of rent).

1.158           This method should generally apply to stapled structures that are established, or leases that are entered into, on or after the transition date. However, this method will also apply to leases entered before 27 March 2018 where the rent had not been agreed by the parties (and therefore not specified in the lease or associated documents) before this date.

1.159           In these circumstances, a statutory concessional cross staple rent cap applies. The amount of the statutory cap broadly reflects the amount of rent that would be paid from the operating entity to the asset entity which would result in the asset entity having a current year net (taxable) income position equal to 80 per cent of the project’s notional current year taxable income.

1.160           The amount of the statutory concessional cross staple rent cap for an income year is worked out applying the steps in Table 1.1.

Table 1.1: Steps for working out the concessional cross staple rent cap

Step 1

Work out a reasonable estimate of the following amount for the relevant asset entity for the income year:

•        if the relevant asset entity is a trust (other than an AMIT) — the amount of its net income or tax loss;

•        if the relevant asset entity is an AMIT — the amount of its trust components with the character of assessable income or its tax loss;

•        if the relevant asset entity is a partnership — the amount of its net income or partnership loss.

Step 2

Work out a reasonable estimate of the following amount for the relevant operating entity for the income year:

•        if the relevant operating entity is a trust (other than an AMIT) — the amount of its net income or tax loss;

•        if the relevant operating entity is a partnership — the amount of its net income or partnership loss;

•        otherwise — the amount of its taxable income or tax loss

Step 3

Add the results of step 1 and step 2

Step 4

Multiply the result of step 3 by 0.8

Step 5

Subtract the result of step 1 from the result of step 4

Step 6

Add the amount of excepted MIT CSA income to the result of step 5

1.161           If the result of step 6 is a positive number, then the concessional cross staple rent cap is that result. Otherwise, the concessional cross staple rent cap is nil. [Schedule 1, items 11 and 12, section 12-444 in Schedule 1 to the TAA 1953 and the definition of ‘concessional cross staple rent cap’ in subsection 995-1(1) of the ITAA 1997]

1.162           For the purposes of steps 1 and 2 of Table 1.1:

•        the amount of a tax loss, or a partnership loss, is treated as a negative number; and

•        any prior year tax losses are disregarded.

[Schedule 1, item 11, subsection 12-444(3) in Schedule 1 to the TAA 1953]

Example 1.20: Existing staple arrangement with no agreed rent

Asset Trust and Op Co entered a cross staple lease arrangement, with effect from 1 July 2017, over an economic infrastructure facility. 

Asset Trust and Op Co are eligible to apply the 15 year MIT cross staple arrangement income transitional rule to the rent earned by Asset Trust on the economic infrastructure facility.

Asset Trust and Op Co had not agreed the amount of rent to be charged under the lease before 27 March 2018. Therefore, the amount of the concessional cross staple rent cap for Asset Trust will be determined using the statutory method.

Asset Trust would need to determine the concessional cross staple rent cap for the 2019-20 income year by applying the steps in Table 1.1.

Step 1: Work out a reasonable estimate of Asset Trust’s net income

At 30 June 2020, a reasonable estimate of Asset Trust’s net income for the income year is as follows:

 

$ million

Cross staple rental income

85

Cross staple interest income

9

Depreciation

(20)

External interest expense

(9)

Prior year tax losses carried forward

(10)

Net income

55

The step 1 amount is a reasonable estimate of Asset Trust’s net income disregarding prior year tax losses — that is, $65 million.

Step 2: Work out a reasonable estimate of Op Co’s taxable income

At 30 June 2020, a reasonable estimate of Op Co’s taxable income for the income year is as follows:

 

$ million

Third party income

105

Cross staple rent expense

(85)

Cross staple interest expense

(9)

Prior year tax losses carried forward

0

Taxable income

11

The step 2 amount is a reasonable estimate of Op Co’s taxable income disregarding prior year tax losses — that is, $11 million.

Step 3: Add the results of step 1 and step 2

The step 3 amount is a reasonable estimate of the notional current year taxable income for the project. This is worked out by adding the results of step 1 ($65 million) and step 2 ($11 million) — that is, $76 million.

Step 4: Multiply the result of step 3 by 0.8

The step 4 amount is worked out by multiplying the notional project taxable income by 0.8. This represents the share of the project’s taxable income that would be allocated to the trust if it received the maximum rent under the concessional rent cap. Therefore, the step 4 amount is:

Step 5: Subtract the result of step 1 from the result of step 4

The step 5 amount compares this notional taxable income cap and the actual taxable income of the trust to determine whether there is an excess of taxable income allocated to the Asset Trust. This is worked out by subtracting the result of step 1 from the result of step 4. Therefore, the step 5 amount is:

The negative amount of $4 million represents excess taxable income that is allocated to Asset Trust.

Step 6: Add the amount of excepted MIT CSA income to the result of step 5

The step 6 amount is worked out by adding the amount of excepted MIT CSA income to the result of step 5. The amount of excepted MIT CSA income is amount of the cross staple rent ($85 million). Therefore, the step 6 amount is:

Therefore, the amount of Asset Trust’s concessional cross staple rent cap is $81 million.

Consequences of breaching the cap

1.163           If the amount of the relevant asset entity’s excepted MIT CSA income exceeds the amount of its concessional cross staple rent cap for the income year, then the excess amount of excepted MIT CSA income will not benefit from the approved economic infrastructure facility exception or the 15 year MIT cross staple arrangement income transitional rule. [Schedule 1, item 11, subsection 12-441(2) in Schedule 1 to the TAA 1953]

1.164           As a result, the excess amount will be non-concessional MIT income that, to the extent it is reflected in a fund payment made to a foreign resident, is subject to MIT withholding at a rate equal to the top corporate tax rate (that is, 30 per cent).

1.165           In addition, if, for the income year, the relevant asset entity is entitled to a deduction against assessable income that arises from rent for land investment and its excepted MIT CSA income exceeds the amount of its concessional cross staple rent cap, then:

•        first, the amount must be deducted against assessable income from that arrangement that is excepted MIT cross staple arrangement income, to the extent that the excepted MIT cross staple arrangement income does not exceed the entity’s concessional cross staple cap;

•        second, if an amount of the deduction remains, the amount can only be deducted against assessable income that is MIT cross staple arrangement income; and

•        third, if an amount of the deduction still remains, the amount can be deducted against any other assessable income.

[Schedule 1, item 11, section 12-445 in Schedule 1 to the TAA 1953]

1.166           If the relevant asset entity is not a MIT, then the relevant asset entity is taken to be a MIT for the purpose of:

•        working out whether its excepted MIT CSA income exceeds the amount of its concessional cross staple rent cap under section 12-441 in Schedule 1 to the TAA 1953; and

•        determining the amount of assessable income that is MIT cross staple arrangement income under section 12-445 in Schedule 1 to the TAA 1953.

[Schedule 1, item 11, subsections 12-441(3) and 12-445(3) in Schedule 1 to the TAA 1953]

Example 1.21: Existing staple arrangement with no agreed rent

Assume the facts are the same as Example 1.17. In addition, assume that:

•        Asset Entity is a MIT that (ignoring the application of the concessional cross staple rent cap and the expense allocation rule) had excepted MIT CSA income which is cross staple rent in relation to the economic infrastructure facility (Facility 1) of $60 million;

•        the concessional cross staple rent cap was $55 million;

•        Asset Entity had third party rental income in relation to a separate facility (Facility 2) it owned of $50 million;

•        Asset Entity had deductible expenses of $20 million; and

•        Asset Entity’s net (taxable) income for the year was $90 million.

When determining the amount of non-concessional MIT income resulting from the breach of the concessional cross staple rent cap, Asset Entity must have regard to the expense allocation rule in section 12-445. 

Asset Entity had determined, based on the usual approach to the allocation of expenses, that expenses directly related to Facility 1 or Facility 2 are to be allocated directly against income from that Facility.  Other indirect expenses are allocated on a pro-rata basis to the income. This allocation resulted in:

•        $12 million of expenses being allocated against the rental income from Facility 1; and

•        $8 million of expenses being allocated against the rental income from Facility 2.

Under the expense allocation rule, the expenses of $12 million that relate to earning the rental income from Facility 1 of $60 million must be first allocated to excepted MIT CSA income.

Therefore, if Asset Entity made a fund payment equal to its net income of $90 million, it would have the following components:

•        a fund payment attributable to cross staple rent of $43 million (that is, $55 million — $12 million) — this amount is excepted MIT CSA income that is subject to 15 per cent MIT withholding; 

•        a fund payment attributable to cross staple rent that is in excess of the concessional cross staple rent cap of $5 million (that is, $60 million — $55 million) — this amount is non-concessional MIT income that is subject to MIT withholding at the top corporate tax rate; and

•        a fund payment attributable to third party rental income of $42 million (that is, $50 million — $8 million) — this amount is subject to 15 per cent MIT withholding.

MIT trading trust income

1.167           The MIT trading trust income rules broadly ensure that distributions from a trading trust to a MIT (either directly or indirectly through a chain of flow-through entities) are treated as non-concessional MIT income and subject to MIT withholding at a rate of 30 per cent — that is, at the rate equal to the top corporate tax rate.

1.168           A MIT will have an amount of MIT trading trust income in relation to an income year if:

•        the MIT has an amount of assessable income for that income year;

•        the amount of assessable income is, or is attributable to, an amount that is derived, received or made from a separate entity (the second entity) — in this case, the second entity will generally make a payment (directly or indirectly through, for example, interposed trusts) to the MIT; and

•        the amount of assessable income is not an amount that is disregarded in calculating a fund payment of a MIT — these amounts include:

-       dividends, interest and royalties;

-       net capital gains in relation to a CGT asset that is not taxable Australian « property » ; and

-       amounts which are not Australian sourced income.

[Schedule 1, item 11, subsection 12-446(1) in Schedule 1 to the TAA 1953]

1.169           The amount will be MIT trading trust income of the MIT if:

•        the MIT holds a total participation interest (as defined in section 960-180 of the ITAA 1997) in the second entity of greater than nil;

•        the amount arises because of that total participation interest;

•        the second entity is:

-       a trading trust in relation to the income year — a trading trust is defined in section 102N of the ITAA 1936 to mean, broadly, a unit trust that carries on trading business (that is, business other than eligible investment business) or that controls, directly or indirectly, the affairs or operations of another entity that carries on a trading business; or

-       a partnership or a trust that is not a unit trust that, if it was a unit trust throughout the income year, would be a trading trust; and

•        the second entity is not a public trading trust in relation to the income year.

[Schedule 1, items 11 and 12, subsection 12-446(2) in Schedule 1 to the TAA 1953 and the definition of ‘MIT trading trust income’ in subsection 995-1(1) of the ITAA 1997]

1.170           However, an amount is not MIT trading trust income of a MIT to the extent that it is attributable to a capital gain that arises because CGT event E4 or CGT event E10 happens — these CGT events happen if, broadly, a trust or an AMIT makes a non-assessable payment to a beneficiary or member. [Schedule 1, item 11, subsection 12-446(3) in Schedule 1 to the TAA 1953]

1.171           Therefore, an amount constitutes MIT trading trust income under section 12-446 in Schedule 1 to the TAA 1953 to the extent that a MIT receives distributions directly, or indirectly through interposed entities, from a trading trust (or another entity which would be a trading trust if it were a unit trust) because these amounts represent trading profits, and therefore are taxed at a rate of 30 per cent. 

1.172           However, arrangements such as a cross staple lease between an asset entity and an operating entity that is a trading trust will be MIT cross staple arrangement income, rather than MIT trading trust income. This is because the rental income received by the MIT (or indirectly flowing to the MIT from a second entity which has a cross staple arrangement) from the trading trust does not arise because of the total participation interest held by the MIT.

 

 

Example 1.22: Distributions from trading trusts



Trading Trust is a trading trust (as defined in section 102N of the ITAA 1936). As it is not a public unit trust under section 102P of the ITAA 1936, it is taxed on a flow-through basis under Division 6 of Part III.

For the income year ended 30 June 2020, Trading Trust has net income of $100,000 consisting of services income and a net capital gain on the sale of a parcel of land.

Hold Trust is a MIT and holds 10 per cent of the units in Trading Trust. For the 30 June 2020 income year, Hold Trust is presently entitled to 10 per cent of the net income of Trading Trust, and includes $10,000 in its assessable income.

The $10,000 is non-concessional MIT income for Hold Trust.

MIT trading trust income — Transitional rules

1.173           The amendments generally apply to a fund payment made by a MIT in relation to an income year if:

•        the fund payment is made on or after 1 July 2019; and

•        the income year is the 2019-20 income year or a later income year.

1.174           However, transitional rules apply in relation to MIT trading trust income that is attributable to assets that exist at the time of announcement of the measure.

1.175           The MIT trading trust income transitional rules apply if:

•        a MIT would have an amount of MIT trading trust income (the relevant amount) for an income year disregarding this transitional rule;

•        immediately before 27 March 2018, the MIT held a total participation interest in the second entity of an amount (the pre-announcement TPI amount) greater than nil; and

•        the amount was derived, received or made by the MIT before 1 July 2026.

[Schedule 1, item 11, subsection 12-447(1) in Schedule 1 to the TAA 1953]

1.176           If a MIT held all of its total participation interests in the second entity immediately before 27 March 2018, the MIT trading trust income transitional rules apply so that all of the relevant amount is taken not to be MIT trading trust income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. [Schedule 1, item 11, subsections 12-447(2), (3) and (5) in Schedule 1 to the TAA 1953]

1.177           If a MIT acquires new participation interests in the second entity on or after 27 March 2018, the MIT trading trust income transitional rules apply so that a part of the relevant amount is taken not to be MIT trading trust income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. The relevant part is worked out using the following formula:

[Schedule 1, item 11, subsections 12-447(2), (3) and (4) in Schedule 1 to the TAA 1953]

1.178           The pre-announcement TPI is the amount of the total participation interests held by the MIT in the second entity immediately before 27 March 2018. [Schedule 1, item 11, paragraph 12-447(1)(b) in Schedule 1 to the TAA 1953]

1.179           The post-announcement TPI is the amount of the total participation interests held by the MIT in the second entity at the end of the most recent income year ending before it derived, received or made the relevant amount. [Schedule 1, item 11, subsection 12-447(4) in Schedule 1 to the TAA 1953]

Example 1.23: Transitional rules for trading trusts

Investment Trust (a MIT) owns 10 per cent of the units in Trading Trust (a trading trust) immediately before 27 March 2018. This represented a 10 per cent total participation interest in Trading Trust.

On 1 July 2019, Investment Trust acquired an additional 5 per cent of the units in Trading Trust. As a result, the total participation interest held by Investment Trust in Trading Trust is increased to 15 per cent.

Trading Trust is a flow-through trust at all times (as it is not a public unit trust under Division 6C of Part III of the ITAA 1936).

On 30 June 2020, Investment Trust received a distribution of $45,000 from Trading Trust which it included in its assessable income. In the absence of the transitional rule, this entire amount would be MIT trading trust income for Investment Trust.

The transitional rule is relevant in working out whether the amount is MIT trading trust income for Investment Trust because:

•        Investment Trust held a total participation greater than nil immediately before 27 March 2018; and

•        the distribution was received before 1 July 2026.

In this regard, only 67 per cent of the assessable distribution is eligible for the transitional relief under the MIT trading trust income transitional rules because:

•        Investment Trust’s pre-announcement TPI was 10 per cent; and

•        Investment Trust’s post-announcement TPI was 15 per cent.

Consequently, for Investment Trust:

•        $30,000 of the assessable distribution will be eligible for the transitional relief (and will not be MIT trading trust income); and

•        $15,000 of the assessable distribution will be MIT trading trust income.

MIT agricultural income

1.180           The MIT agricultural income rules ensure that amounts of assessable income of a MIT that are attributable to an asset (whether or not held by the MIT) that is Australian agricultural land for rent are treated as non-concessional MIT income and subject to MIT withholding at a rate of 30 per cent — that is, at the rate equal to the top corporate tax rate.

1.181           MIT agricultural income is an amount of assessable income of a MIT to the extent that the amount is attributable to an asset that is Australian agricultural land for rent (whether or not held by the MIT).  [Schedule 1, items 11 and 12, subsection 12-448(2) in Schedule 1 to the TAA 1953 and the definition of ‘MIT agricultural income’ in subsection 995-1(1) of the ITAA 1997]

1.182           Australian agricultural land for rent is Division 6C land situated in Australia that:

•        is used, or could reasonably be used, for carrying on a primary production business; and

•        is held primarily for the purposes of deriving or receiving rent.

[Schedule 1, items 11 and 12, subsection 12-448(3) in Schedule 1 to the TAA 1953 and the definition of ‘Australian agricultural land for rent’ in subsection 995-1(1) of the ITAA 1997]

1.183           Division 6C land is land (within the meaning of Division 6C of Part III of the ITAA 1936) and includes a thing if an investment in the thing would be an investment in land under subsection 102MB(1) of the ITAA 1997. [Schedule 1, items 11 and 12, subsection 12-448(5) in Schedule 1 to the TAA 1953 and the definition of ‘Division 6C land’ in subsection 995-1(1) of the ITAA 1997]

1.184           Therefore, Division 6C land includes an interest in land and fixtures on land. It also includes investments in moveable « property » , being « property » that is:

•        incidental to and relevant to the renting of the land;

•        customarily supplied or provided in connection with the renting of the land; and

•        ancillary to the ownership and use of the land.

1.185           Agricultural land for rent will include land that is held primarily for the purpose of deriving rent where the lessee or another entity uses the land to carry on a primary production business.

1.186           However, if agricultural land was held in a trust not primarily for the purposes of deriving rent, the MIT trading trust income rules may apply.

1.187           Agricultural land that has been rezoned, where the new zoning does not allow use for a primary production business, would no longer constitute Australian agricultural land for rent.

1.188           If an economic infrastructure facility is a fixture on Australian agricultural land for rent:

•        the economic infrastructure facility is taken as being separate from the Australian agricultural land for rent; and

•        the economic infrastructure facility is not Australian agricultural land for rent.

[Schedule 1, item 11, subsection 12-448(4) in Schedule 1 to the TAA 1953]

Example 1.24: Agricultural land left vacant

A MIT holds land that is leased to a third party who previously used it for a dairy farm. Although the milking station and the shed are still standing, there are no more cows on the land. The land is left vacant by the tenant due to a recent drop in milk prices.

The land is Australian agricultural land for rent because it:

•        could reasonably be used for carrying on another primary production business; and

•        is held by the MIT primarily for the purposes of deriving rent.

The rental income, and any gain made on the disposal of the land, is MIT agricultural income as it will be attributable to Australian agricultural land for rent. This remains the case even if the future purchaser intends to use the land for non-primary production business.

Example 1.25: Share of MIT agricultural income

Trust A holds an asset that is an Australian agricultural land for the purpose of deriving rent from a third party.

MIT Q is not entitled to distribution from Trust A, but is entitled to receive an amount from Trust A that is calculated by reference to the rent income that Trust A receives on the land. This may include (but is not limited to) an entitlement that arises, through the use of a derivative.

This amount is attributable to an asset that is an Australian agricultural land for rent and therefore is MIT agricultural income.

Capital gains from membership interests

1.189           MIT agricultural income includes amounts that are, or are attributable to, a capital gain that arises if a CGT event happens in relation to an asset that is a membership interest held in an entity that holds, directly or indirectly, one or more assets that are:

•        Australian agricultural land for rent; or

•        residential dwelling assets.

[Schedule 1, item 11, subsection 12-453(1) in Schedule 1 to the TAA 1953]

1.190           If a membership interest in the test entity passes a modified principal asset test, immediately before the time that the CGT event happens to the membership interest, then (subject to a tie breaker rule) the capital gain that arises from the CGT event may be attributable to:

•        Australian agricultural land for rent that gives rise to MIT agricultural income; or

•        residential dwelling assets that give rises to MIT residential housing income.

[Schedule 1, item 11, subsection 12-453(2) in Schedule 1 to the TAA 1953]

1.191           The operation of these rules is explained later in this Chapter.

MIT agricultural income — Transitional rules

1.192           The amendments generally apply to a fund payment made by a MIT in relation to an income year if:

•        the fund payment is made on or after 1 July 2019; and

•        the income year is the 2019-20 income year or a later income year.

1.193           However, transitional rules apply so that an amount (the relevant amount) is not treated as MIT agricultural income of a MIT if, among other things:

•        the relevant amount is included in the assessable income of the MIT;

•        the relevant amount would be MIT agricultural income (disregarding the transitional rule) of the MIT because it is attributable to an asset that is Australian agricultural land for rent;

•        the MIT derived, received or made the relevant amount before 1 July 2026.

[Schedule 1, item 11, section 12-449 in Schedule 1 to the TAA 1953]

1.194           The MIT agricultural income transitional rule ensures that assessable income attributable to Australian agricultural land for rent held, directly or indirectly, as at 27 March 2018 (the date of announcement for this measure) will not be treated as MIT agricultural income until 1 July 2026.

1.195           If the MIT derived, received or made the relevant amount because it held the asset directly, the transitional rule will apply if:

•        the MIT held the asset just before 27 March 2018; or

•        before 27 March 2018, the MIT entered into a contract for the acquisition or lease of the asset.

[Schedule 1, item 11, paragraph 12-449(1)(d) in Schedule 1 to the TAA 1953]

1.196           In these circumstances, the transitional rule will apply so that the relevant amount is not treated as MIT agricultural income and will continue to be eligible for the concessional 15 per cent MIT withholding rate. [Schedule 1, item 11, subsection 12-449(2) in Schedule 1 to the TAA 1953]

1.197           If the MIT derived, received or made the relevant amount because it held a total participation interest (the pre-announcement TPI) of greater than nil in another entity (the second entity) which held the asset, the transitional rule will apply if:

•        the second entity held the asset before 27 March 2018; or

•        before 27 March 2018, the second entity entered into a contract for the acquisition or lease of the asset.

[Schedule 1, item 11, paragraph 12-449(1)(e) and (f) in Schedule 1 to the TAA 1953]

1.198           In these circumstances, if the MIT held all of its total participation interests in the second entity immediately before 27 March 2018 (that is, if its pre-announcement TPI is 100 per cent), the whole of the relevant amount is not treated as MIT agricultural income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. [Schedule 1, item 11, subsections 12-449(3), (4) and (6) in Schedule 1 to the TAA 1953]

1.199           If a MIT acquires new participation interests in the second entity on or after 27 March 2018 (that is, if its pre-announcement TPI is less than 100 per cent), a part of the relevant amount is not treated as MIT agricultural income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. The relevant part is worked out using the following formula:

[Schedule 1, item 11, subsections 12-449(3), (4) and (5) in Schedule 1 to the TAA 1953]

1.200           The post-announcement TPI is the amount of the total participation interests held by the MIT in the second entity at the end of the most recent income year ending before it derived, received or made the relevant amount. [Schedule 1, item 11, subsection 12-449(5) in Schedule 1 to the TAA 1953]

MIT residential housing income

1.201           The MIT residential housing income rules ensure that amounts of assessable income of a MIT that are attributable to an asset (whether or not held by the MIT) that is residential housing (other than affordable housing or disability accommodation) are treated as non-concessional MIT income and subject to MIT withholding at a rate of 30 per cent — that is, at the rate equal to the top corporate tax rate.

1.202           MIT residential housing income is defined as any assessable income of a MIT to the extent it is attributable to a residential dwelling asset (whether or not held by the MIT). [Schedule 1, items 11 and 12, paragraph 12-450(1)(a) and subsection 12-470(2) in Schedule 1 to the TAA 1953 and the definition of ‘MIT residential housing income’ in subsection 995-1(1) of the ITAA 1997]

1.203           However, an amount included in assessable income of a MIT is not MIT residential housing income if it is:

•        a dividend, interest or a royalty subject to, or exempted from, withholding tax;

•        a net capital gain from a CGT event that happens in relation to a CGT asset that is not taxable Australian « property » ; or

•        not from an Australian source.

[Schedule 1, item 11, paragraph 12-450(1)(b) in Schedule 1 to the TAA 1953]

1.204           A residential dwelling asset is an asset that is:

•        a dwelling;

•        taxable Australian real « property » ; and

•        residential premises but not commercial residential premises.

  [Schedule 1, items 11 and 12, subsection 12-452(1) in Schedule 1 to the TAA 1953 and the definition of ‘residential dwelling asset’ in subsection 995-1(1) of the ITAA 1997]

1.205           MIT residential housing income of a MIT is the assessable income of a MIT that is attributable to residential dwelling assets (such as rent, net capital gains and licence fees). It also includes income from derivative arrangements such as an acquisition of a rental income stream from residential housing.

1.206           However, to encourage investment in affordable housing, an amount is not MIT residential housing income to the extent it relates to use of dwellings to provide affordable housing. [Schedule 1, item 11, subsection 12-450(3) in Schedule 1 to the TAA 1953]

Example 1.26: MIT residential housing and income from mixed use developments

MWT is a MIT that has an interest in a mixed use residential development consisting of a number of units.

The units are dwellings that are residential premises (but not commercial residential premises) and taxable Australian real « property » . Some but not all of the units in the development are used to provide affordable housing.

Amounts of the assessable income of MWT that are attributable to the units that are not used to provide affordable housing are MIT residential housing income. Fund payments attributable to those amounts are subject to MIT withholding tax at a rate of 30 per cent.

However, amounts of the assessable income of MWT that are attributable to the units that are used to provide affordable housing are not MIT residential housing income. Fund payments attributable to those amounts are subject to MIT withholding tax at the existing rate (usually 15 per cent).

Dwelling

1.207           For income to be MIT residential housing income, it must be attributable to a residential dwelling asset. The first requirement to be a residential dwelling asset is that the asset must be a dwelling. In this context, dwelling takes its existing meaning in the income tax law. [Schedule 1, item 11, paragraph 12-452(1)(a) in Schedule 1 to the TAA 1953]

1.208           Dwelling , as defined in section 118-115 of the ITAA 1997, includes:

•        a unit of accommodation that is a building (for example a house) or part of a building (for example an apartment or townhouse) that consists wholly or mainly of residential accommodation; and

•        any land immediately under the unit of accommodation.

1.209           It also includes certain adjacent land that, together with the land under the dwelling, does not exceed two hectares, and adjacent structures (for example, a storeroom, shed or garage). This is achieved by applying section 118-120 of the ITAA 1997 that operates to extend adjacent land in relation to dwellings in the capital gains tax provisions in the tax law.

1.210           Schedule 1 ensures that the adjacent land concept can apply to common areas that are used by occupants of a number of different dwellings for private and domestic use. This ensures that section 118-120 of the ITAA 1997 applies appropriately to adjacent land in relation to assets held by MITs. [Schedule 1 item 11, subsections 12-452(2) and (3) in Schedule 1 to the TAA 1953]

Taxable Australian real « property »

1.211           The second requirement to be a residential dwelling asset is that the dwelling must be taxable Australian real « property » . [Schedule 1, item 11, paragraph 12-452(1)(b) in Schedule 1 to the TAA 1953]

1.212           The term taxable Australian real « property » is defined in section 855-20 of the ITAA 1997 to include, among other things, real « property » situated in Australia (including a lease of land, if the land is situated in Australia).

1.213           This requirement reflects that the policy of the Government relates to residential housing in Australia rather than in other jurisdictions.

Residential premises

1.214           The third requirement to be a residential dwelling asset is that the asset must be residential premises other than commercial residential premises. [Schedule 1, item 11, paragraph 12-452(1)(c) in Schedule 1 to the TAA 1953]

1.215           The term residential premises is defined in subsection 995-1(1) of the ITAA 1997 as having the same meaning as in the GST Act. Section 195-1 of the GST Act provides that the term residential premises means land or a building that:

•        is occupied as a residence or for residential accommodation; or

•        is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation.

1.216           The definition specifies that land or a building that meets these requirements is residential premises regardless of the term of the occupation or intended occupation.

1.217           Broadly, land or a building will be residential premises if it provides, at a minimum, shelter and basic living facilities and is either occupied by a person or designed for occupation. This is to be ascertained by an objective consideration of the character of the « property » — the purpose for which an entity may hold the « property » is not relevant.

1.218           Residential premises need only be suitable for occupation, rather than long-term occupation — it includes, for example, a room that may only be suitable for short term accommodation. However, it does not include things that people may occupy that are not land or a building, such as a caravan, houseboat or mobile home.

1.219           While caravans, houseboats and other mobile homes are included in the definition of dwelling for CGT purposes, they are not residential premises and are outside the scope of this measure.

Commercial residential premises

1.220           However, a residential dwelling asset does not include residential premises that are commercial residential premises. [Schedule 1, item 11, paragraph 12-452(1)(c) in Schedule 1 to the TAA 1953]

1.221           The term commercial residential premises is defined as having the same meaning as in the GST Act. Section 195-1 of the GST Act defines commercial residential premises as:

•        a hotel, motel, inn, hostel or boarding house;

•        premises used to provide accommodation in connection with a school;

•        a ship that is mainly let out on hire in the ordinary course of a business of letting ships out on hire;

•        a ship that is mainly used for entertainment or transport in the ordinary course of a business of providing ships for entertainment or transport;

•        a marina at which one or more of the berths are occupied, or are to be occupied, by ships used as residences;

•        a caravan park or a camping ground; or

•        anything similar to residential premises described in the preceding dot points.

1.222           The exclusion of commercial residential premises reflects the intention of the amendments to remove tax advantages for MITs investing in Australia in dwellings suitable for use as housing.

Disability accommodation

1.223           A residential dwelling asset also does not include residential premises if those premises are either:

•        both:

-       used primarily to provide specialist disability accommodation (within the meaning of the National Disability Insurance Scheme (Specialist Disability Accommodation Conditions) Rule 2018 ); and

-       enrolled to provide specialist disability accommodation in accordance with the National Disability Insurance Scheme (Specialist Disability Accommodation Conditions) Rule 2018 ; or

•        disability accommodation of a kind prescribed in the regulations.

[Schedule 1, item 11, paragraphs 12-452(1)(d) and (e) in Schedule 1 to the Taxation Administration Act 1953]

1.224           This ensures that MITs can receive concessional MIT taxation treatment when investing in dwellings used to provide disability accommodation.

1.225           A dwelling used to provide specialist disability accommodation will not be a residential dwelling asset if it is enrolled as specialist disability accommodation under the NDIS, as specified under the National Disability Insurance Scheme (Specialist Disability Accommodation Conditions) Rule 2018.

1.226           The regulations may also prescribe further categories of premises used to provide disability accommodation as not being a residential dwelling asset. This ensures this rule can be updated to reflect changes to the NDIS rules or other changes in the way accommodation support is provided to individuals with a disability. [Schedule 1, item 11, paragraph 12-452(1)(e) in Schedule 1 to the Taxation Administration Act 1953]

1.227           The amendments relating to disability accommodation do not affect the general requirement that, for a MIT’s investment in land to be eligible investment business, the investment must be undertaken primarily for the purpose of deriving rent. The amendments also do not affect any of the other circumstances in which the income of a MIT may be non-concessional MIT income.

Providing affordable housing

1.228           An amount of income attributable to an asset will not be MIT residential housing income to the extent that it is referable to the use of the asset to provide affordable housing. [Schedule 1, item 11, subsection 12-450(3) in Schedule 1 to the TAA 1953]

1.229           The circumstances in which a dwelling is used to provide affordable housing are defined in section 980-5 in item 3 of Schedule 3 to the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018.

1.230           Broadly, to satisfy this definition for a day, an asset must be tenanted or available to be tenanted under the management of an eligible community housing provider and that provider must have issued the owner with a certificate covering the asset for the relevant period. The tenants or occupants must also not hold an interest of 10 per cent or more in the MIT.

1.231           Where an asset is used to provide affordable housing and for other income producing purposes from housing, only the amount of income that results from providing affordable housing potentially receives concessional treatment (and is not MIT residential housing income).

1.232           Schedule 5 to this Bill contains contingent amendments that apply if the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Act 2019 has not commenced at or prior to the commencement of Schedules 1 to 4 to this Bill. This ensures that the provisions in this Schedule apply to identify the meaning of providing affordable housing. [Schedule 5, items 1 to 6]

1.233           Schedule 5 includes the same meaning of providing affordable housing as Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No. 2) Bill 2018. [Schedule 5, item 1]

Capital gains from assets used to provide affordable housing

1.234           If an amount of assessable income is attributable to a capital gain, it will only be treated as being referable to the use of the dwelling to provide affordable housing (and therefore is not MIT residential housing income) if the asset has been used to provide affordable housing for at least 3,650 days. The use of the dwelling to provide affordable housing must occur on or after 1 July 2017 but before the CGT event happens and does not need to be a consecutive period. [Schedule 1, item 11, subsection 12-450(4) in Schedule 1 to the TAA 1953]

Indirect income

1.235           MIT residential housing income includes all amounts included in a MIT’s assessable income that are attributable to residential dwelling assets. This can include amounts a MIT receives, whether directly or indirectly, if those amounts are ultimately attributable to the use of a residential dwelling asset by that entity or another entity.

1.236           This will be the case even if the MIT has an amount of assessable income that is ultimately attributable to income from such an asset that the MIT has received indirectly via a number of intermediaries.

1.237           This ensures that the same outcome applies to all amounts of assessable income of a MIT that are ultimately attributable to a residential dwelling asset.

Example 1.27: MIT residential housing income

A MIT holds an interest in Trust A, which holds an interest in Trust B.

Trust B derives income that is:

•        attributable to a residential dwelling asset; and

•        is not used to provide affordable housing.

Therefore, any amount included in the assessable income of the MIT as a result of a distribution from Trust A that is attributable to the income from the dwelling received by Trust B is MIT residential housing income.

Example 1.28: MIT residential housing income

Trust C holds a residential dwelling asset that is not used to provide affordable housing) for the purpose of deriving rent from a third party.

ABC MIT is not entitled to a distribution from Trust C. However, it is entitled to receive an amount from Trust C that is calculated by reference to the rental income (not merely because it is serviced out of rent income) that Trust C receives on the dwelling.

This amount is MIT residential housing income as it is attributable to the dwelling.

Capital gains from membership interests

1.238           MIT residential housing includes amounts that are, or are attributable to, a capital gain that arises if a CGT event happens in relation to an asset that is a membership interest held in an entity that holds, directly or indirectly, one or more assets that are:

•        Australian agricultural land for rent; or

•        residential dwelling assets.

[Schedule 1, item 11, subsection 12-453(1) in Schedule 1 to the TAA 1953]

1.239           If a membership interest in the test entity passes a modified principal asset test, immediately before the time that the CGT event happens to the membership interest, then (subject to a tie breaker rule) the capital gain that arises from the CGT event may be attributable to:

•        Australian agricultural land for rent that gives rise to MIT agricultural income; or

•        residential dwelling assets that give rises to MIT residential housing income.

[Schedule 1, item 11, subsection 12-453(2) in Schedule 1 to the TAA 1953]

1.240           The operation of these rules is explained later in this Chapter.

MIT residential housing income — Transitional rules

1.241           The amendments generally apply to a fund payment made by a MIT in relation to an income year if:

•        the fund payment is made on or after 1 July 2019; and

•        the income year is the 2019-20 income year or a later income year.

1.242           However, transitional rules apply so that an amount (the relevant amount) is not treated as MIT residential housing income of a MIT if, among other things:

•        the relevant amount is included in the assessable income of the MIT;

•        the relevant amount would be MIT residential housing income of the MIT disregarding this transitional rule because it is attributable to a facility that consists of or contains a residential dwelling asset; and

•        the MIT derived, received or made the relevant amount before 1 October 2027.

[Schedule 1, item 11, section 12-451 in Schedule 1 to the TAA 1953]

1.243           The MIT residential housing income transitional rules ensure that MITs directly or indirectly holding residential premises when this measure was first announced on 14 September 2017 in a press release by the former Treasurer have a 10 year transitional period before the measure applies to assets they held at the time of the announcement.

1.244           The transitional rule provides certainty to MITs and their investors for existing investments by ensuring that existing investments at the time of the policy announcement are unaffected by the changes for the transitional period.

1.245           The transitional rules will be met if a MIT or another entity in which a MIT held any participation interest has entered into a contract for the acquisition or creation of a facility that consists of or contains a dwelling prior to the transition time. However, these rules will not be met if the MIT or the other entity has merely acquired land or entered into a contract for the acquisition of land without any commitment to acquire or create a dwelling on the land.

1.246           A contract to acquire land will not be a contract for the acquisition of a facility, as land is not a facility in and of itself.

1.247           If the MIT derived, received or made the relevant amount because it held the facility directly, the transitional rule will apply if:

•        the MIT held the facility just before the transition time; or

•        before the transition time, the MIT entered into a contract for the acquisition, creation or lease of the facility.

[Schedule 1, item 11, paragraph 12-451(1)(d) in Schedule 1 to the TAA 1953]

1.248           In these circumstances, the transitional rule will apply so that the relevant amount is not treated as MIT residential housing income and will continue to be eligible for the concessional 15 per cent MIT withholding rate. [Schedule 1, item 11, subsection 12-451(2) in Schedule 1 to the TAA 1953]

1.249           The transition time is 4.30 pm (by legal time in the Australian Capital Territory) on 14 September 2017. [Schedule 1, item 11, subsection 12-451(7) in Schedule 1 to the TAA 1953]

1.250           If the MIT derived, received or made the relevant amount because it held a total participation interest (the pre-announcement TPI) of greater than nil in another entity (the second entity) which held the facility, the transitional rule will apply if:

•        the second entity held the facility before the transition time; or

•        before the transition time, the second entity entered into a contract for the acquisition or lease of the facility.

[Schedule 1, item 11, paragraph 12-451(1)(e) and (f) in Schedule 1 to the TAA 1953]

1.251           In these circumstances, if the MIT held all of its total participation interests in the second entity immediately before the transition time (that is, if its pre-announcement TPI is 100 per cent), the whole of the relevant amount is not treated as MIT residential housing income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. [Schedule 1, item 11, subsections 12-451(3), (4) and (6) in Schedule 1 to the TAA 1953]

1.252           If a MIT acquires new participation interests in the second entity at or after the transition time (that is, if its pre-announcement TPI is less than 100 per cent), a part of the relevant amount is not treated as MIT residential housing income and will continue to be eligible for the concessional 15 per cent MIT withholding rate for the specified period. The relevant part is worked out using the following formula:

[Schedule 1, item 11, subsections 12-451(3), (4) and (5) in Schedule 1 to the TAA 1953]

1.253           The post-announcement TPI is the amount of the total participation interests held by the MIT in the second entity at the end of the most recent income year ending before it derived, received or made the relevant amount. [Schedule 1, item 11, subsection 12-451(5) in Schedule 1 to the TAA 1953]

MIT agricultural income and MIT residential housing income — Capital gains from membership interests

1.254           MIT agricultural income and MIT residential housing income includes amounts that are, or are attributable to, a capital gain that arises if a CGT event happens in relation to an asset that is a membership interest held in an entity that holds, directly or indirectly, one or more assets that are:

•        Australian agricultural land for rent; or

•        residential dwelling assets.

[Schedule 1, item 11, subsection 12-453(1) in Schedule 1 to the TAA 1953]

1.255           In this regard, a capital gain is taken to be attributable to Australian agricultural land for rent or residential dwelling assets if the membership interest passes a modified version of the principal asset test in section 855-30 of the ITAA 1997 immediately before the time that the CGT event happens in relation to membership interests in the test entity.

1.256           The modified principal asset test requires references to taxable Australian real « property » in the test entity to be treated as if they are references to an asset that is:

•        Australian agricultural land for rent; or

•        a residential dwelling asset.

[Schedule 1, item 11, subsection 12-453(3) in Schedule 1 to the TAA 1953]

1.257           A membership interest will pass the standard principal asset test in the income tax law if the combined market value of all the assets of the test entity that are taxable Australian real « property » exceed the combined market value of all of its other assets.

1.258           The membership interest will satisfy the modified principal asset test if the sum of the market values of the test entity’s membership interests that are Australian agricultural land for rent and/or residential dwelling assets exceeds the sum of the market values of the test entity’s other assets.

1.259           If a membership interest in the test entity passes the modified principal asset test, immediately before the time that the CGT event happens to the membership interest, then (subject to a tie breaker rule) the capital gain that arises from the CGT event may be attributable to:

•        Australian agricultural land for rent that give rise to MIT agricultural income; or

•        residential dwelling assets that give rise to MIT residential housing income.

[Schedule 1, item 11, subsection 12-453(2) in Schedule 1 to the TAA 1953]

1.260           In these circumstances, if all the assets in the test entity are Australian agricultural land for rent, then the capital gain that arises from the CGT event is taken to be wholly attributable to Australian agricultural land for rent. [Schedule 1, item 11, subparagraph 12-453(2)(a)(i) in Schedule 1 to the TAA 1953]

1.261           Similarly, if all the assets in the test entity are residential dwelling assets, then the capital gain that arises from the CGT event is taken to be wholly attributable to residential dwelling assets. [Schedule 1, item 11, subparagraph 12-453(2)(a)(ii) in Schedule 1 to the TAA 1953]

1.262           However, if some assets in the test entity are Australian agricultural land for rent and some assets are residential dwelling assets, then:

•        if the market value of the membership interests that are attributable to Australian agricultural land for rent is equal to or exceeds the market value of the membership interests that are attributable to residential dwelling assets — the capital gain from the CGT event in relation to the membership interest is taken to be wholly attributable to Australian agricultural land for rent; or

•        if the market value of the membership interests that are attributable to Australian agricultural land for rent is less than the market value of the membership interests that are attributable to residential dwelling assets — the capital gain from the CGT event in relation to the membership interest is taken to be wholly attributable to residential dwelling assets.

[Schedule 1, item 11, subparagraphs 12-453(2)(a)(iii) and (iv) in Schedule 1 to the TAA 1953]

1.263           For these purposes, the market values of the relevant assets are the market values of those assets just before the time that the relevant CGT event happens. [Schedule 1, item 11, subsection 12-453(4) in Schedule 1 to the TAA 1953]

Example 1.29: Capital gain on sale of membership interests attributable to Australian agricultural land for rent

A MIT is the sole unit holder of Trust X. The trustee of Trust X is the sole unit holder of Trust A and Trust B. The MIT sells its interest in Trust X.

Trust A holds only agricultural land that is leased to a third party who uses the land to operate an agricultural business. The market value of the agricultural land assets held by Trust A at the time of sale is $80 million.

Trust B holds only commercial properties that are leased to a third party. The market value of the commercial properties held by Trust B at the time of sale is $20 million.

As references in section 855-30 of the ITAA 1997 to taxable Australian real « property » are instead taken to be references to an asset that is Australian agricultural land for rent , units in Trust X will pass the principal asset test.

This is because 80 per cent of the assets of Trust X are made up of its interest in Trust A, which under the modified principal assets test is treated as having the same character (Australian agricultural land for rent) as its underlying assets.

Passing the modified principal asset test means that MIT’s entire interest in Trust X is treated as being an asset that is a Australian agricultural land for rent.

Accordingly, when the MIT disposes of its units in Trust X, the whole amount of any capital gain is attributable to Australian agricultural land for rent. If that amount is a net capital gain included in assessable income, the amount will be MIT agricultural income.

Example 1.30: Capital gain on sale of membership interests attributable to residential dwelling assets

MIT Q is the sole unit holder of Trust X.

The trustee of Trust X is the sole unit holder of Trust A and Trust B.

Trust A’s only assets are residential dwelling assets that are not used to provide affordable housing. The market value of Trust A’s assets is $80 million.

Trust B’s only assets are commercial properties that are leased to a third party. The market value of Trust B’s assets is $20 million.

As Trust X’s interest in Trust A constitutes 80 per cent of its assets, MIT Q’s interest in Trust X passes the modified principal asset test. This is because:

•        Trust X’s interest in Trust A makes up more than 50 per cent of its assets; and

•        under the principal asset test, this interest is treated as having the same character as the underlying assets.

Passing the modified principal asset test means that MIT Q’s entire interest in Trust X is treated as being an asset that is a residential dwelling asset.

Accordingly, when MIT Q disposes of its units in Trust X, the whole amount of any capital gain is attributable to a residential dwelling asset. If that amount is a net capital gain included in assessable income, the amount will be MIT residential housing income.

Application and transitional provisions

1.264           The amendments made by Schedule 1 to this Bill apply to a fund payment made by a MIT in relation to an income year if:

•        the fund payment is made on or after 1 July 2019; and

•        the income year is the 2019-20 income year or a later income year.

[Schedule 1, subitem 16(1)]

1.265           The amendments also apply for the purposes of working out the MIT cross staple arrangement income of a MIT for a previous income year as mentioned in section 12-438 in Schedule 1 to the TAA 1953 — that is, for the purposes of applying the de minimis exception for MIT cross staple arrangement income. [Schedule 1, subitem 16(2)]

1.266           Therefore, for fund payments made in relation to the 2019-20 income year, the de minimis exception that applies to MIT cross staple arrangement income may be available if, in the 2018-19 income year, the amount of notional cross staple arrangement income of the relevant test entity would not have breached the de minimis thresholds set out in section 12-438 in Schedule 1 to the TAA 1953.

1.267           The amendments to insert a definition of industrial, commercial or scientific equipment into subsection (6)(1) of the ITAA 1936 applies in relation to amounts paid or credited on or after 1 July 2019. [Schedule 1, subitem 16(3)]

1.268           Section 25-115 of the ITAA 1997, which allows an entity that is an operating entity in relation to a cross staple lease of an approved economic infrastructure facility to deduct an amount of rent from land investment for an income year, applies in relation to an amount of rent from land investment that is derived or received in relation to the 2019-20 income year or a later income year. [Schedule 1, subitem 16(4)]

1.269           Section 25-120 of the ITAA 1997, which allows an entity that is an operating entity in relation to a cross staple lease to deduct an amount of rent from land investment for an income year if the MIT cross staple transitional rules apply to a cross staple arrangement:

•        applies in relation to an amount of rent from land investment that is derived or received on or after 27 March 2018; and

•        applies for the purposes of working out whether an entity can deduct an amount for rent from land investment for an income year that is before the 2019-20 income year.

[Schedule 1, subitems 16(4) and (5)]

1.270           This application of section 25-120 to allow an entity to deduct an amount for rent from land investment for an income year that is before the 2019-20 income year was sought by stakeholders to clarify the existing law and protect existing arrangements entered into by affected taxpayers.

1.271           The amendments made by Schedule 5 generally apply to in relation to tenancies starting before, at or after 1 January 2018. [Schedule 5, item 7]

1.272           The amendments made by Schedule 5 will commence only if the Schedule 3 to the Treasury Laws Amendment (Reducing Pressure on Housing Affordability Measures No 2) Act 2019 does not commence before the commencement of this Bill. [Section 2]

Transitional rules

1.273           Transitional rules apply to fund payments attributable to existing investments. These transitional rules have been sought by stakeholders to ensure that there is no adverse impact on MITs or investors for existing assets held or contracts that were entered into to acquire assets or create or construct assets where these arrangements were in place at the time the changes were announced.

1.274           If the transitional rules apply, the existing MIT withholding tax rate of 15 per cent will continue to apply until broadly:

•        for MIT cross staple arrangement income relating to a facility that is not an economic infrastructure facility — 1 July 2026;

•        for MIT cross staple arrangement income relating to a facility that is an economic infrastructure facility — 1 July 2034;

•        for MIT trading trust income — 1 July 2026;

•        for MIT agricultural income — 1 July 2026; and

•        for MIT residential housing income — 1 October 2027.

1.275           The details of the transitional rules are outlined earlier in this Chapter in the context of the explanation of each type of MIT cross staple arrangement income.

 

 



Chapter 2          

Thin capitalisation

Outline of chapter

2.1                   Schedule 2 to this Bill amends the ITAA 1997 to improve the integrity of the income tax law by modifying the thin capitalisation rules to prevent double gearing structures.

2.2                   All references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

2.3                   The thin capitalisation rules (Division 820) apply to foreign controlled Australian entities, Australian entities that operate internationally and foreign entities that operate in Australia. In the case of an entity that is not an ADI, the rules operate to, broadly, deny deductions for debt financing expenses if the entity’s debt exceeds certain limits (and the entity is therefore thinly capitalised). These limits are determined by reference to the greater of a ‘safe harbour’ debt amount, a ‘worldwide gearing’ debt amount and an ‘arm’s length’ debt amount.

2.4                   Foreign investors are increasingly entering into ‘double gearing’ structures that allow them to convert more of their active business income to interest income that is subject to interest withholding tax of 10 per cent, or less in certain circumstances.

2.5                   Double gearing structures involve multiple layers of flow-through holding entities (trusts or partnerships) that each issue debt against the same underlying asset. This allows investors to provide a greater proportion of their capital as investor debt and gear higher than the thin capitalisation limits allow. As a result, investors are able to maintain and deduct higher levels of debt financing expenditure.

2.6                   The ‘associate entity’ provisions in Subdivision 820-I are intended to prevent double gearing by requiring grouping of associate entities (essentially where there is a controlling interest of 50 per cent or more) when working out each entity’s debt limits under the thin capitalisation rules, including its limit under the safe harbour debt amount. Broadly, these rules look to the underlying assets of the entity and under the safe harbour debt amount, allow gearing of up to 60 per cent of those underlying assets, effectively preventing re-gearing of the same underlying assets using layers of entities (that is, cascading equity).

2.7                   It is common in some sectors for consortiums to provide funding through a combination of equity and debt. These investors typically have controlling interests of 20 per cent to 40 per cent and therefore fall below the 50 per cent threshold. Consequently, these investors are able to minimise tax through double gearing.

Example 2.1: Double gearing in relation to the safe harbour debt amount

SPV Trust 1, SPV Trust 2 and Trust are subject to the thin capitalisation rules. All monetary values reflect the values of the relevant assets, debt and equity at each measurement day in a period in accordance with Subdivision 820-G.

Trust holds $300 million of assets (that are not interests in other entities). Therefore, the safe harbour debt amount should be $180 million (60 per cent of $300 million).

SPV Trust 1 and SPV Trust 2 have direct control interests in Trust of 33.33 per cent each. This is below the 50 per cent or more threshold for Trust to constitute an associate entity for SPV Trust 1 and SPV Trust 2. Therefore, the interests held by SPV Trust 1 and SPV Trust 2 in Trust do not give rise to associate entity equity.

Consequently, the safe harbour debt amount for both SPV Trust 1 and SPV Trust 2 is $24 million (60 per cent of $40 million).

Through the insertion of the SPV Trusts, the Foreign Pension Funds are able to inject an additional $48 million of debt into the structure, and claim interest deductions for that debt (because the debt levels in SPV Trust 1, SPV Trust 2 and Trust are within their respective safe harbour debt amounts). This is despite no change in the level of the underlying assets (that are not interests in other entities).

2.8                   To address this concern, the Government is improving the integrity of the income tax law by lowering the associate entity threshold under the thin capitalisation rules from 50 per cent or more to 10 per cent or more (where they apply to determine associate entity debt, associate entity equity and the associate entity excess amount) for interests in trusts and partnerships. This will prevent foreign investors from using multiple layers of flow-through entities to convert trading income into favourably taxed interest income.

Summary of new law

2.9                   Schedule 2 to this Bill amends the ITAA 1997 to improve the integrity of the income tax law by modifying the thin capitalisation rules to prevent double gearing structures.

2.10               For the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount under the thin capitalisation provisions, a trust (other than a public trading trust) or partnership that is an associate of the other entity referred to in the relevant provisions will be an associate entity of that other entity if the other entity holds an associate interest of 10 per cent or more in that trust or partnership.

2.11               In addition, in determining the arm’s length debt amount, an entity must consider the debt to equity ratios in entities that are relevant to the considerations of an independent lender or borrower.

Comparison of key features of new law and current law

New law

Current law

For the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount under the thin capitalisation provisions, a trust (other than a public trading trust) or partnership that is an associate of the other entity referred to in the relevant provisions will be an associate entity of that other entity if the other entity holds an associate interest of 10 per cent or more in that trust or partnership.

For the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount under the thin capitalisation provisions, a trust or partnership that is an associate of the other entity referred to in the relevant provisions will be an associate entity of that other entity if the other entity holds an associate interest of 50 per cent or more in that trust or partnership.

In determining the arm’s length debt amount, an entity must consider the debt to equity ratios in entities that are relevant to the considerations of an independent lender or borrower.

No equivalent.

Detailed explanation of new law

2.12               Schedule 2 to this Bill amends the ITAA 1997 to improve the integrity of the income tax law by modifying the thin capitalisation rules to prevent double gearing structures.

2.13               To achieve this, the amendments modify the operation of the thin capitalisation associate entity test (section 820-905) for the purposes of determining:

•        associate entity debt (section 820-910);

•        associate entity equity (section 820-915); and

•        the associate entity excess amount (section 820-920).

[Schedule 2, item 3, subsection 820-905(2B)]

2.14               The modifications apply if the first entity mentioned in subsection 820-905(1) or (2A) is a trust (other than a public trading trust) or a partnership. [Schedule 2, item 3, subsection 820-905(2B)]

2.15               The amendments do not affect the operation of the thin capitalisation associate entity test for corporate limited partnerships (because of section 94K of the ITAA 1936).

2.16               The effect of the modifications is to:

•        lower the thin capitalisation associate entity test from 50 per cent or more to 10 per cent or more; and

•        ensure that subsection 318(5) of the ITAA 1936 is disregarded — as a result, a public unit trust (other than a public trading trust) will be taken to be a trust for the purposes of applying the thin capitalisation associate entity test.

[Schedule 2, item 3, paragraphs 820-905(2B)(a) and (c)]

2.17               In addition, as an integrity measure, the other entity mentioned in subsection 820-905(1) or (2A) is taken as holding an associate interest in the first entity of 10 per cent if:

•        that other entity actually holds an associate interest in the first entity of less than 10 per cent; and

•        it is reasonable to conclude that the entity, or one of the entities, who created this circumstance did so for the principal purpose of, or for more than one principal purpose that included the purpose of, ensuring that the first entity will not be an associate entity of the other entity.

[Schedule 2, item 3, paragraph 820-905(2B)(b) and subsection 820-905(2C)]

2.18               An entity that created such a circumstance will include a participant or arranger who, either alone or together with others, implements, carries out or enters into an arrangement, or that causes another entity to implement, carry out or enter into an arrangement that results in, brings about or contributes to the circumstance.

2.19               The principal purpose of an entity is one of the main purposes of the entity having regard to all the facts and circumstances. This recognises that an entity can have a number of purposes when creating, entering into or participating in an arrangement, some or all of which are principal purposes.

2.20               Therefore, where there is a principal purpose of ensuring that the first entity will not be an associate entity of the other entity and a principal purpose of achieving a particular commercial objective, the principal purpose test would be met.

Example 2.2: An entity that is treated as holding an associate interest of 10 per cent

Foreign Pension Fund wishes to acquire an investment in Trust 2 in Australia, alongside other investors. The investment is set up such that Foreign Pension Fund has a 100 per cent direct control interest in each of Trusts 1W, 1X, 1Y and 1Z.

Each of those trusts have a 7.5 per cent direct control interest in Trust 2 and are subject to the thin capitalisation rules.

One of the principal purposes of setting up the investment in this way is to ensure that Trust 2 will not be an associate entity of Trusts 1W, 1X, 1Y and 1Z (as they each have a direct control interest below the 10 per cent threshold).

In this situation, paragraph 820-905(2B)(b) and subsection 820-905(2C) apply so that Trust 2 is deemed to be an associate entity of Trusts 1W, 1X, 1Y and 1Z for the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount.

2.21               Finally, if a trust (other than a public trading trust) is a partner in a partnership and another entity (the benefiting entity) benefits under the trust (as determined under paragraph 318(6)(a) of the ITAA 1936), then in determining whether an entity is an associate of another entity, the benefiting entity is taken to be a partner in the partnership. [Schedule 2, item 3, paragraph 820-905(2B)(d) and subsection 820-905(2D)]

Example 2.3: Impact of the amendments on double gearing in relation to the safe harbour debt amount

Assume the facts are the same as for Example 2.1.

Subsection 820-905(2B) ensures that the direct control interests of 33.33 per cent held by each of SPV Trust 1 and SPV Trust 2 in Trust will give rise to associate entity equity.

SPV Trust 1 and SPV Trust 2 will need to reduce the average value of their assets by the average value of the associate entity equity. This means the safe harbour debt amounts for both SPV Trust 1 and SPV Trust 2 are nil.

The safe harbour debt amount for Trust remains $180 million.

2.22               In response to the changes to the thin capitalisation associate entity provisions, investors may attempt to double gear by calculating a thin capitalisation arm’s length debt amount (section 820-105 for an outward investing entity that is not an ADI and section 820-215 for an inward investing entity that is not an ADI).

2.23               For the purposes of determining the arm’s length debt amount, regard must be had to the factors specified in subsections 820-105(3) and 820-215(3).

2.24               To safeguard against investors attempting to double gear in this way, the amendments clarify that, for the purposes of determining the arm’s length debt amount, the debt to equity ratios of any entities in which the entity has a direct or indirect interest is a factor that must also be taken into account, to the extent the interest is relevant and material to the considerations of both a prudent independent borrower and a prudent independent lender. [Schedule 2, items 1 and 2, subparagraphs 820-105(3)(g)(iv) and 820-215(3)(g)(iv)]

2.25               Under this factor, the ability of relevant investments of the entity to act as security (or asset backing) to support the entity's debt is determined taking into account the burden of any debt claims the investments already have against their underlying assets (whether held directly or indirectly through further interposed entities). This would be customary in third party lending due diligence assessments.

2.26               All of the relevant factors specified in subsections 820-105(3) and 820-215(3) must be taken into account in determining the arm’s length debt amount. However, this does not mean that every single factor will have a material impact on the quantum of the arm’s length debt amount. Therefore, subparagraphs 820-105(3)(g)(iv) and 820-215(3)(g)(iv) do not require an assessment of direct and indirect interests that are irrelevant or immaterial to a prudent independent borrower and lender.

2.27               The interests to be taken into account would need to be of material consideration to the borrower and lender in the context of the entity's portfolio of assets. Whether an interest is relevant in particular circumstances would depend on:

•        the characteristics of the interest — that is, for example, whether the interest is a legal interest, an equitable interest, a contractual interest or an interest in possession; and

•        the relative size, quality, value, significance and importance of the interest in context.

2.28               The indicators of relevance include, but are not limited to, whether:

•        the interest constitutes the sole or predominate asset of the entity that secures and services the entity's debt; or

•        the interest is one of many other assets of the entity but is highly valuable.

2.29               The inclusion of the new factor in paragraphs 820-105(3)(g) and 820-215(3)(g) does not affect the interpretation of the other factors that must be taken into account in determining the arm's length debt amount, but needs to be taken into account with the other factors.

Example 2.4: Consideration of the factor in subparagraph 820-215(3)(g)(iv)

Assume the facts are the same as for Example 2.1, except that SPV Trust 1 holds a range of interests in other entities and the investment in Trust is material to SPV Trust 1.

SPV Trust 1 calculates an arm’s length debt amount under section 820-215. The factual assumptions under subsection 820-215(2) are applied. All the factors under subsection 820-215(3) are taken into account, including the factor in subparagraph 820-215(3)(g)(iv).

When considering the factor in subparagraph 820-215(3)(g)(iv), it is recognised that SPV Trust 1’s interest in Trust is relevant to the considerations of a prudent independent borrower and a prudent independent lender in the context of the range of interests that SPV Trust 1 holds. This is because of the characteristics, size, quality, value, significance and importance of the interest in the context of SPV Trust 1’s portfolio of assets.

The impact of the debt to equity ratio of Trust is taken into account. That is, the amount of debt that SPV Trust 1 can support involves looking to the level of debt held by Trust. This is because the debt held against the underlying assets impacts the inherent value and quality of SPV Trust 1’s asset base that can act as security for its own debt.

This is also considered along with all the other factors in subsection 820-215(3).

Application and transitional provisions

2.30               The amendments to prevent double gearing structures through the thin capitalisation rules apply to income years starting on or after 1 July 2018. [Schedule 2, item 4]

2.31               The amendments were announced on 27 March 2018 and will prevent taxpayers from being able to obtain unintended benefits by exploiting a loophole in the thin capitalisation rules. In this regard, the majority of income tax returns that will be first affected will be lodged in 2020 at the earliest.

 



Outline of chapter

3.1                   Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.2                   All references in this Chapter are to the ITAA 1936 unless otherwise stated.

Context of amendments

3.3                   A foreign resident that derives dividends or interest paid by an Australian resident generally has a liability to withholding tax in respect of the payment (section 128B). However, a withholding tax liability does not arise if the foreign resident is a superannuation fund for foreign residents which is exempt from income tax in the country in which it resides (paragraph 128B(3)(jb)). Generally, the dividends or interest are also NANE income of the superannuation fund (section 128D).

3.4                   The exemption from dividend and interest withholding tax makes it very attractive for these superannuation funds to gear their Australian equity investments using investor debt to lower their overall Australian tax on the investments. Combined with a stapled structure, this exemption can result in these superannuation funds paying little Australian tax on Australian business activities.

3.5                   In addition, the broad exemption from dividend and interest withholding tax puts these superannuation funds in a better financial position than other investors. For example:

•        foreign corporate entities typically pay 10 per cent interest withholding tax on interest income; and

•        Australian investors pay tax on interest income at their marginal tax rates.

3.6                   To address these concerns, the Government has decided to limit the withholding tax exemption for superannuation funds for foreign residents to portfolio-like investments only. As a result, interest and dividend income derived by superannuation funds for foreign residents from non-portfolio like investments will be taxed.

Summary of new law

3.7                   Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.8                   Therefore, a superannuation fund for foreign residents will not be liable to withholding tax on amounts of interest, dividends or non-share dividends it receives from an Australian entity only if:

•        the income derived by the superannuation fund is exempt from income tax in the country in which it resides;

•        the superannuation fund has a portfolio like interest in the entity that pays the dividends, non-share dividends or interest to it; and

•        the superannuation fund does not have influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the entity that pays the dividends, non-share dividends or interest to it .

Comparison of key features of new law and current law

New law

Current law

A superannuation fund for foreign residents will not be liable to withholding tax on amounts of interest, dividends or non-share dividends it receives from an Australian entity if:

•        the income derived by the superannuation fund is exempt from income tax in the country in which it resides;

•        the superannuation fund has a portfolio-like interest in the entity that pays the dividends, non-share dividends or interest to it; and

•        the superannuation fund does not have influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the entity that pays the dividends, non-share dividends or interest to it.

A superannuation fund for foreign residents is not liable to withholding tax on amounts of interest, dividends or non-share dividends it receives from an Australian entity if the income derived by the fund is exempt from income tax in the country in which it resides.

Detailed explanation of new law

3.9                   Schedule 3 to this Bill amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

3.10               A superannuation fund for foreign residents (as defined in section 118-520 of the ITAA 1997) is, broadly, a fund that:

•        is a provident, benefit, superannuation or retirement fund that is indefinitely continuing;

•        was established in a foreign country;

•        was established and is maintained for foreign residents; and

•        has its central management and control carried on outside Australia by entities that are foreign residents.

3.11               The withholding tax exemption for superannuation funds for foreign residents will be limited to interest, dividend and non-share dividend income derived from an entity in which a superannuation fund has a portfolio-like interest — that is, where the superannuation fund does not have a non-portfolio holding of 10 per cent or more and does not have influence of the kind described in subsection 128B(3CD) in relation to the entity.

3.12               Consequently, a superannuation fund for foreign residents will be exempt from withholding tax under paragraph 128B(3)(jb) only if:

•        the superannuation fund satisfies the portfolio interest test in subsection 128B(3CC) in relation to the test entity:

-       at the time the income was derived; and

-       throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time;

•        the superannuation fund does not, at the time the income was derived, have influence of the kind described in subsection 128B(3CD) in relation to the test entity; and

•        the income is not NANE income of the superannuation fund because the superannuation fund is a covered sovereign entity.

[Schedule 3, items 1 and 2, subsection 128B(3CA)]

3.13               The test entity is generally the entity that paid the interest, dividends or non-share dividends (as mentioned in subparagraph 128B(3)(jb)(ii)). However, if the superannuation fund for foreign residents derives the income because it is a beneficiary of an Australian resident trust (that is, if subsection 128A(3) applies), the test entity is the Australian resident trust. [Schedule 3, item 2, subsection 128B(3CB)]

The portfolio interest test

3.14               A superannuation fund satisfies the portfolio interest test in subsection 128B(3CC) in relation to the test entity if the sum of the total participation interests (as defined in section 960-180 of the ITAA 1997) the superannuation fund holds in the test entity:

•        is less than 10 per cent; and

•        if the test entity has any non-share equity interests, would be less than 10 per cent if, in working out the direct participation interest (under section 960-190 of the ITAA 1997) that any entity holds in a company, both:

-       an equity holder were treated as a shareholder; and

-       the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company.

[Schedule 3, item 2, subsection 128B(3CC)]

3.15               A superannuation fund for foreign residents must apply the portfolio interest test in respect of the interest it holds in the test entity.

The influence test

3.16               A superannuation fund for foreign residents has influence of the kind described in subsection 128B(3CD) in relation to the test entity if:

•        the superannuation fund, acting alone or in concert with others, is directly or indirectly able to determine the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity’s operations; or

•        at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of the superannuation fund (whether those directions, instructions or wishes are expressed directly or indirectly, or through the superannuation fund acting in concert with others).

[Schedule 3, item 2, subsection 128B(3CD)]

3.17               For the purposes of determining whether a superannuation fund for foreign residents has the requisite level of influence, any breach of terms of a debt interest by any entity is disregarded. [Schedule 3, item 2, subsection 128B(3CE)]

3.18               A superannuation fund for foreign residents must apply the influence test in respect of the influence it has in relation to the test entity.

3.19               A superannuation fund will indirectly have influence of the kind described in the influence test where, for example, the influence or ability to influence the test entity is held by an Australian resident entity that is controlled by the superannuation fund.

Example 3.1: Dividend withholding tax exemption applies

SFFR is a superannuation fund for foreign residents. SFFR holds 8 per cent of the ordinary share capital of Aus Co.

The rights attached to the ordinary shares acquired by SFFR are identical to the rights of all other ordinary shareholders in Aus Co. SFFR has no capacity to influence (either directly or indirectly) Aus Co in any way outside of its basic rights as a minority holder of ordinary shares.

There are no other factors present which indicate SFFR can influence Aus Co in any way.

SFFR holds a total participation interest in Aus Co of less than 10 per cent and does not have influence in relation to Aus Co of the kind described in the influence test.

Therefore, any dividends paid by Aus Co to SFFR will be exempt from dividend withholding tax under paragraph 128B(3)(jb).

Example 3.2: Dividend subject to withholding tax

SFFR is a superannuation fund for foreign residents. SFFR holds 15 per cent of the ordinary share capital of Aus Co.

SFFR holds a total participation interest in Aus Co of more than 10 per cent.

Therefore, any dividends paid by Aus Co to SFFR will not be exempt from dividend withholding tax under paragraph 128B(3)(jb).

Example 3.3: Dividend and interest withholding tax exemption applies

FSF is a superannuation fund for foreign residents. FSF holds 8 per cent of the issued units of Aus Trust.

The rights attached to the units acquired by FSF are identical to the rights of all other unitholders in Aus Trust. FSF has no capacity to influence (either directly or indirectly) Aus Trust in any way outside of its basic rights as a minority holder of units.

Aus Trust is an Australian resident managed fund which holds two investments:

•        15 per cent of the ordinary shares in Portfolio Investment Co; and

•        a bond.

There are no other factors present which indicate FSF can influence Aus Trust in any way.

FSF holds a total participation interest in Aus Trust of less than 10 per cent and does not have influence in relation to Aus Trust of the kind described in the influence test.

Therefore, any dividends (on the shares held in Portfolio Investment Co) or interest (on the bond) that flows to FSF through Aus Trust will be exempt from dividend and interest withholding tax under paragraph 128B(3)(jb).

Example 3.4: Dividend subject to withholding tax

SFFR is a superannuation fund for foreign residents. SFFR holds 8 per cent of the ordinary share capital of Aus Co.

Under Aus Co’s constitution, any investor with an equity interest of 8 per cent or more is entitled to appoint an individual to an Advisory Board of Aus Co. The Board of Directors of Aus Co cannot make certain decisions in relation to the control and direction of Aus Co’s operations without the Advisory Board’s approval.

In these circumstances, SFFR has influence in relation to Aus Co of the kind described in the influence test.

Therefore, any dividends paid by Aus Co to SFFR will not be entitled to a dividend withholding tax exemption under paragraph 128B(3)(jb).

Application and transitional provisions

3.20               The amendments to limit the withholding tax exemption for superannuation funds for foreign residents apply to income that is derived by a superannuation fund on or after 1 July 2019. [Schedule 3, subitem 3(1)]

3.21               A seven year transitional rule applies to assets acquired by a superannuation fund for foreign residents on or before 27 March 2018. In these circumstances, the amendments apply to income derived by a superannuation fund in respect of such an asset on or after 1 July 2026.

3.22               Under the transitional rule, the amendments apply to an income that is derived by a superannuation fund on or after 1 July 2026 if:

•        the income was derived by the superannuation fund in respect of an asset;

•        the superannuation fund did not derive the income because it was presently entitled to the income as a beneficiary of a trust — that is, subsection 128A(3) does not apply to the income; and

•        the superannuation fund acquired the asset on or before 27 March 2018.

[Schedule 3, subitem 3(2)]

3.23               In addition, under the transitional rule, the amendments apply to income that is derived by a superannuation fund on or after 1 July 2026 if:

•        the superannuation fund derived the income because it was presently entitled to the income as a beneficiary of a trust because it holds an interest in the trust — that is, because of the operation of subsection 128A(3);

•        the superannuation fund started to hold the interest in the trust on or before 27 March 2018;

•        the dividend, non-share dividend or interest that was included in the income of the trust as mentioned in subsection 128A(3) was so included in respect of an asset; and

•        the trustee of the trust acquired the asset on or before 27 March 2018.

[Schedule 3,  subitem 3(3)]

3.24               The transitional rules ensure that there is no immediate adverse impact on superannuation funds for foreign residents for investments held at the time the changes were announced.

 



Chapter 4          

Sovereign immunity

Outline of chapter

4.1                   Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

4.2                   The Income Tax Rates Amendment (Sovereign Entities) Bill 2018 makes consequential amendments to the Income Tax Rates Act 1986 to specify that sovereign entities are liable to income tax on taxable income at a rate of 30 per cent.

4.3                   All references in this Chapter are to the ITAA 1997 unless otherwise stated.

Context of amendments

4.4                   Broadly, certain income and gains from Australian investments are currently exempt from Australian income tax if they are derived by a foreign government, or by a foreign entity that is wholly-owned by a foreign government (commonly known as a sovereign wealth fund).

4.5                   The exemption is based on the international law doctrine of sovereign immunity (see I Congreso del Partido (1981) 2 All ER 1064). This international law doctrine is unclear in its application and different countries take different approaches to how the immunity is implemented in practice.

4.6                   In ATO ID 2002/45, the Commissioner states that:

Certain income derived from within Australia by foreign governments is exempt from Australian tax under the international law doctrine of sovereign immunity. In accordance with that doctrine, Australia accepts that any income derived by a foreign government from the performance of governmental functions within Australia is exempt from Australian tax. An activity undertaken by a foreign Government Agency will generally be accepted as the performance of governmental functions provided that it is functions of government, provided that the agency is owned and controlled by the government and does not engage in commercial activities.

4.7                   In practice, the Commissioner exempts investment income and gains derived by foreign governments and foreign government agencies from tax where:

•        the monies invested are and will remain government monies; and

•        the income is derived from a non-commercial activity. 

4.8                   In determining whether an investment in an entity is a commercial activity, the Commissioner takes into account the size of the direct and indirect investment and the actual or potential influence that may be exercised in respect of the entity’s financial, operating and policy decisions.

4.9                   Where the sovereign immunity tax exemption applies, the Commissioner accepts that the sovereign entity will be exempt from income tax and withholding tax.

4.10               The Government has decided to create a legislative framework for the existing tax concession for foreign governments (including sovereign wealth funds) and, among other things, limit the exemption to portfolio-like investments in certain assets.

4.11               In addition, income flowing through Australian trusts will only be able to access the sovereign immunity tax exemption if the paying trust is a MIT and the income is not non-concessional MIT income.

Summary of new law

4.12               Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

4.13               An amount of ordinary income or statutory income of a sovereign entity will be NANE income if, broadly:

•        the amount is a return on a portfolio-like membership interest, debt interest or non-share equity interest in an Australian company or MIT; and

•        no member of the sovereign entity group has influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the Australian company or MIT.

4.14               An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax.

4.15               Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, a sovereign entity will be liable to pay income tax on its taxable income at a rate of 30 per cent — that is, the rate equal to the top corporate tax rate.

Comparison of key features of new law and current law

New law

Current law

An amount of ordinary income or statutory income of a sovereign entity will be NANE income if, broadly:

•        the amount is a return on a portfolio-like membership interest, debt interest or non-share equity interest in an Australian company or MIT; and

•        no member of the sovereign entity group has influence (either directly or indirectly) over decisions that comprise the control and direction of the operations of the Australian company or MIT.

An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax.

Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, a sovereign entity will be liable to pay income tax on its taxable income at a rate of 30 per cent.

No equivalent.

Detailed explanation of new law

4.16               Schedule 4 to this Bill amends the ITAA 1936 and the ITAA 1997 to codify and limit the scope of the sovereign immunity tax exemption.

What is a sovereign entity?

4.17               A sovereign entity is any of the following:

•        a body politic of a foreign country or a part of a foreign country;

•        a foreign government agency; or

•        a foreign resident entity in which a body politic of a foreign country or a part of a foreign country, or a foreign government agency, holds a total participation interest of 100 per cent.

[Schedule 4, items 6 and 9, section 880-15 and the definition of ‘sovereign entity’ in subsection 995-1(1)]

4.18               A foreign government agency is defined in subsection 995-1(1) to mean:

•        the government of a foreign country or a part of a foreign country;

•        an authority of the government of a foreign country; or

•        an authority of the government of part of a foreign country.

4.19               A sovereign entity is liable to pay tax on its taxable income. [Schedule 4, item 6, section 880-55]

4.20               For the purposes of applying the income tax law, a body politic of a foreign country or a part of a foreign country, or a foreign government agency in relation to a foreign country (including a foreign government agency in relation to part of a foreign country), is taken to be:

•        a person who is a foreign resident; and

•        a resident of the foreign country.

[Schedule 4, item 6, section 880-60]

4.21               Unless another provision in the Income Tax Rates Act 1986 applies to set a different rate, the rate of income tax payable by a sovereign entity on its taxable income is 30 per cent — that is, the rate equal to the top corporate tax rate. [Schedule 1 to the Income Tax Rates Amendment (Sovereign Entities) Bill 2018, items 1 to 3, section 30 of the Income Tax Rates Act 1986]

4.22               Another provision in the Income Tax Rates Act 1986 will apply if, for example, a sovereign entity is a company or a trust. In these circumstances, the rate of income tax payable by the sovereign entity on its taxable income will be the relevant corporate tax rate or the relevant trustee tax rate.

What is a covered sovereign entity?

4.23               Certain income of a sovereign entity that is covered by section 880-125 (a ‘covered sovereign entity’) will be NANE income. A sovereign entity is a covered sovereign entity if:

•        the sovereign entity is funded solely by public monies;

•        all returns on the sovereign entity’s investments are public monies;

•        the sovereign entity is not a partnership; and

•        the sovereign entity is not:

-       a public non-financial entity; or

-       a public financial entity (other than a public financial entity that only carries on central banking activities).

[Schedule 4, item 6, subsection 880-125(1)]

4.24               An entity is a public non-financial entity if its principal activity is:

•        producing or trading non-financial goods; and/or

•        providing services that are not financial services.

[Schedule 4, items 6 and 9, subsection 880-130(1) and the definition of ‘public non-financial entity’ in subsection 995-1(1)]

4.25               An entity is a public financial entity if:

•        the entity trades in financial assets;

•        the entity operates commercially in the financial markets; and/or

•        the principal activities of the entity include providing any of the following financial services:

-       financial intermediary services, including deposit-taking and insurance services;

-       financial auxiliary services, including brokerage, foreign exchange and investment management services; and/or

-       capital financial institution services, including financial services in relation to assets or liabilities that are not available on open financial markets.

[Schedule 4, items 6 and 9, paragraphs 880-130(2)(a) to (c) and the definition of ‘public financial entity’ in subsection 995-1(1)]

4.26               The definitions of public non-financial entity and public financial entity are based on concepts in:

•        the International Monetary Fund Government Finance Statistics Manual 2014 ; and

•        the Australian Bureau of Statistics manual ABS — Australian System of Government Finance Statistics: Concepts, Sources And Methods — 5514.0 of 2015.

4.27               Public non-financial entities include entities such as airline corporations, postal authorities, state water corporations and port authorities. They also include public non-profit institutions engaging in market production (such as hospitals, schools, or colleges) if they are separate institutional units and charge economically significant prices.

4.28               Public financial entities include deposit-taking corporations, financial intermediaries (such as banks), financial auxiliaries and captive financial institutions.

NANE income of a covered sovereign entity — income from holding certain interests

4.29               If a sovereign entity is a covered sovereign entity, an amount of its ordinary income or statutory income is NANE income if:

•        the amount is a return on a membership interest, a debt interest or a non-share equity interest that the sovereign entity holds in another entity (the test entity);

•        at the time the amount becomes ordinary income or statutory income of the sovereign entity (the income time), the test entity is either an Australian resident company or a MIT (including a MIT that is an AMIT);

•        the sovereign entity group of which the sovereign entity is a member satisfies the portfolio interest test in subsection 880-105(4) in relation to the test entity:

-       at the income time; and

-       throughout any 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

•        the sovereign entity group of which the sovereign entity is a member does not have influence of the kind described in subsection 880-105(6) in relation to the test entity at the income time.

[Schedule 4, item 6, subsection 880-105(1)]

4.30               For these purposes, a membership interest, a debt interest or a non-share equity interest that a sovereign entity holds as a partner in a partnership is disregarded. [Schedule 4, item 6, subsection 880-105(2)]

4.31               If an amount is ordinary income of a sovereign entity, the income time will generally be the time that the income is derived. If the amount is statutory income of a sovereign entity, the income time will generally be the time that is stated in the provision that creates the statutory income or the time when the income is taken to be derived.

4.32               However, if the test entity is a MIT in relation to the income year in which the sovereign entity derives or receives the amount, the amount will not be NANE income of the sovereign entity to the extent that:

•        the amount is attributable to a fund payment; and

•        the fund payment is attributable to non-concessional MIT income (including MIT cross staple arrangement income that is disregarded because of the approved economic infrastructure facility exception or the non-concessional MIT income transitional rule).

[Schedule 4, item 6, subsection 880-105(3)]

4.33               A covered sovereign entity cannot deduct an amount if:

•        the amount is a loss in respect of a membership interest, a debt interest or a non-share equity interest that the sovereign entity holds in an Australian resident company or a MIT (the test entity); and

•        the portfolio interest test in subsection 880-105(3) or the influence test in subsection 880-105(5) would be satisfied in relation to the test entity on the assumption that the amount were an amount of ordinary or statutory income at the time it arose.

[Schedule 4, item 6, section 880-110]

4.34               This ensures that, if a covered sovereign entity makes a loss on the disposal of a membership interest, a debt interest or a non-share equity interest in another entity, the sovereign entity cannot deduct an amount in respect of the loss on the assumption that the investment is of a kind that would have been NANE income. Similarly, under the general deduction provision in the income tax law, losses and outgoings incurred by a sovereign entity in deriving NANE income are not deductible.

4.35               A capital gain made by a covered sovereign entity from a CGT event that happens in relation to a CGT asset will be disregarded if:

•        the CGT asset is a membership interest, non-share equity interest or debt interest in another entity (the test entity) that is an Australian resident company or a MIT; and

•        the portfolio interest test in subsection  880-105(3) or the influence test in subsection 880-105(5) would be satisfied in relation to the test entity on the assumption that the capital gain were an amount of ordinary or statutory income immediately before the time the CGT event happened.

[Schedule 4, item 6, section 880-115]

4.36               Similarly, a capital loss of a covered sovereign entity from a CGT event that happens in relation to a CGT asset will be disregarded if, on the assumption that the capital loss was a capital gain, the capital gain would be disregarded because of section 880-115. [Schedule 4, item 6, section 880-120]

4.37               Broadly, the following amounts derived, received or made by a covered sovereign entity may be NANE income (or disregarded in calculating statutory income):

•        dividends — including non-share dividends and dividends that pass through a MIT;

•        interest — including interest that passes through a MIT;

•        fund payments made by a MIT (other than fund payments that are attributable to non-concessional MIT income); and

•        net capital gains and revenue gains made on the disposal of an interest in the test entity — including gains that pass through a MIT.

4.38               An amount of ordinary income or statutory income that is NANE income of a sovereign entity is also exempt from withholding tax .

4.39               In addition, if a sovereign entity is a beneficiary of a trust, the trustee of the trust will not be liable to tax under subsection 98(3) of the ITAA 1936 on any amount that is NANE income of the sovereign entity. [Schedule 4, item 1, section 99GA of the ITAA 1936]

Example 4.1: Sovereign wealth fund acquires an interest in a stapled structure

SWF is a covered sovereign entity that holds a portfolio (5 per cent) interest in:

•        ordinary units in Asset Trust (which is a MIT); and

•        ordinary shares in Op Co.

Asset Trust and Op Co are stapled entities that entered a cross staple arrangement in respect of an economic infrastructure facility. SWF (or other members in its sovereign entity group) have no other rights in respect of the stapled entities. 

Because of the operation of the transitional rules that apply to cross stapled arrangements, the cross staple lease payments are not MIT cross staple arrangement income of Asset Trust until 1 July 2034.

SWF acquired its interest in the stapled entities on 1 July 2018. In addition, SWF satisfies the portfolio interest test and the influence test in section 880-105.

Therefore, any dividends or other distributions that SWF receives on the shares it holds in Op Co will be NANE income.

In addition, any distributions that SWF receives on the units it holds in Asset Trust will be NANE income if they are not fund payments attributable to non-concessional MIT income (or MIT cross staple arrangement income that is disregarded in certain circumstances).

In this regard, the cross staple rental payments from Op Co to Asset Trust are not non-concessional MIT income until 1 July 2034 because of the MIT cross staple arrangement income transitional rule which applies to stapled structures with an economic infrastructure facility.

However, ignoring those transitional provisions, these amounts would be MIT cross staple arrangement income from 1 July 2019. Therefore, any fund payments from Asset Trust to SWF made on or after 1 July 2019 that are attributable to this cross staple rental arrangement will not be NANE income under Division 880.

Sovereign entity groups

4.40               In determining whether a covered sovereign entity can access the sovereign immunity tax exemption, the entity must consider the total level of interest and influence that it, together with its sovereign entity group, has in the investment asset.

4.41               A sovereign entity group consists of each entity that is a part of the sovereign entity group. [Schedule 4, items 6 and 9, section 880-20 and the definition of ‘sovereign entity group’ in subsection 995-1(1)]

4.42               Each entity that is part of a sovereign entity group is a member of the group. [Schedule 4, items 6 and 8, subsection 880-20(3) and paragraph (bd) of the definition of ‘member’ in subsection 995-1(1)]

4.43               Consequently:

•        sovereign entities of the same foreign government will be members of the same sovereign entity group; and

•        sovereign entities of the same part of a foreign government will be members of the same sovereign entity group.

4.44               Therefore, for countries with different levels of government (such as federal and state governments, or federal, state and provincial governments):

•        the federal government would be considered the government of a foreign country under subsection 880-20(1); and

•        the state and provincial governments would respectively be considered governments of separate parts of that foreign country under subsection 880-20(2).

4.45               Consequently, the grouping of the sovereign entities occurs at:

•        the federal level for federal entities; and

•        the state or provincial level respectively for entities that are part of the state or provincial level government.

Example 4.2: Sovereign entity groups for multiple levels of government

Country A is a country that has a federal system of government. State X is a state of Country A. 

Federal Government Investment Authority and Federal Government Reserve Fund are agencies of Country A’s federal government that satisfy the requirements to be a sovereign entity.

SPV is a wholly-owned entity of Federal Government Investment Authority and also satisfies the requirements to be a sovereign entity.

State X Investment Authority and State X Reserve Fund are agencies of State X of Country A that satisfy the requirements to be a sovereign entity.

SPV 1 is a wholly-owned entity of State X Investment Authority and also satisfies the requirements to be a sovereign entity.

For the purposes of Division 880, there are two sovereign entity groups.

The Federal Government and the State Government each has its own sovereign entity group.

Under subsection 880-20(1), one sovereign entity group consists of:

•        the Federal Government Investment Authority;

•        the Federal Government Reserve Fund; and

•        SPV.

Under subsection 880-20(2), another sovereign entity group consists of:

•        the State X Investment Authority;

•        the State X Reserve Fund; and

•        SPV 1.

Portfolio interest test

4.46               A sovereign entity group satisfies the portfolio interest test in subsection 880-105(4) in relation to an entity (the test entity) at a time if, at that time, the sum of the total participation interests (as defined in section 960-180) that each member of the sovereign entity group holds in the test entity:

•        is less than 10 per cent; and

•        would be less than 10 per cent if, in working out the direct participation interest (under section 960-190) that any entity holds in a company:

-       an equity holder were treated as a shareholder; and

-       for any non-share equity interests, the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company.

[Schedule 4, item 6, subsection 880-105(4)]

4.47               In working out the sum of the total participation interests held by each member of the group in the test entity, a particular direct or indirect participation interest held in the test entity is taken into account only once. [Schedule 4, item 6, subsection 880-105(5)]

4.48               A sovereign entity group must apply the portfolio interest test in respect of the interest it holds in the test entity. The test entity is the entity from which the sovereign entity group derives or receives an amount of ordinary income or statutory income — that is, it is the entity in which the sovereign entity group holds the first level of its investment into Australia. Consequently, where a sovereign entity invests in an Australian MIT, an assessment must be made of the sovereign entity group’s level of interest in that MIT.

The influence test

4.49               A sovereign entity group has influence of the kind described in subsection 880-105(6) in relation to an entity (the test entity) at a time if, at that time:

•        a member of the sovereign entity group, acting alone or in concert with others, is directly or indirectly able to determine the identity of at least one of the persons who, individually or together with others, make (or might reasonably be expected to make) the decisions that comprise the control and direction of the test entity’s operations; and/or

•        at least one of those persons is accustomed or obliged to act, or might reasonably be expected to act, in accordance with the directions, instructions or wishes of a member of the sovereign entity group (whether those directions, instructions or wishes are expressed directly or indirectly, or through the member of the sovereign entity group acting in concert with others).

[Schedule 4, item 6, subsection 880-105(6)]

4.50               For the purposes of determining whether a sovereign entity group has the requisite level of influence, any breach of terms of a debt interest by any entity is disregarded. [Schedule 4, item 6, subsection 880-105(7)]

4.51               For the purposes of applying the influence test in subsection 880-105(6) in relation to a test entity, an entity is taken to be a member of the sovereign entity group if it is a foreign resident entity in which the relevant body politic or foreign government agency holds a total participation interest of more than 50 per cent. [Schedule 4, item 6, subsection 880-105(8)]

4.52               A sovereign entity group will indirectly have influence of the kind described in the influence test where, for example, the influence or ability to influence the tested entity is held by an Australian resident entity that is controlled by the sovereign entity group.

4.53               A sovereign entity group must apply the influence test in respect of the influence it has in relation to the test entity. The test entity is the entity from which the sovereign entity group derives or receives an amount of ordinary income or statutory income — that is, it is the entity in which the sovereign entity group holds the first level of its investment into Australia.

Example 4.3: Portfolio interest test satisfied

SWF is a corporate entity which is wholly-owned by a foreign government. SWF:

•        is fully funded by general tax revenue raised by the foreign government;

•        will ultimately distribute all profits made to the foreign government as dividends; and

•        is a foreign resident for income tax purposes.

As part of its portfolio investments, SWF has acquired less than 1 per cent of the ordinary share capital of Listed Company. Listed Company is an Australian resident company listed on the Australian Securities Exchange. No other member of SWF’s sovereign entity group holds a direct or indirect interest in Listed Company.

The rights attached to the ordinary shares acquired by SWF are identical to the rights of all other ordinary shareholders in Listed Company. SWF has no capacity to influence (either directly or indirectly) Listed Company in any way outside of its basic rights as a minority holder of ordinary shares.

In addition, the sovereign entity group of which SWF is a member has no capacity to influence Listed Company in any way.

SWF’s sovereign entity group holds a total participation interest in Listed Company of less than 10 per cent and does not have influence in relation to Listed Company of the kind described in the influence test.

Therefore, any dividends paid by Listed Company to SWF will be NANE income under Division 880.

Example 4.4: Portfolio interest test not satisfied

SWF 1 and SWF 2 are corporate entities which are wholly-owned by the same foreign government. Both SWF 1 and SWF 2:

•        are fully funded by general tax revenue raised by the foreign government;

•        will ultimately distribute all profits made to the foreign government as dividends; and

•        are foreign residents for income tax purposes.

SWF 1 has acquired 7 per cent of the ordinary share capital of ABC Pty Ltd. SWF 2 has acquired 8 per cent of the ordinary share capital of ABC Pty Ltd.

As SWF 1 and SWF 2 are both wholly-owned by the same foreign government, they are members of the same sovereign entity group. Consequently, the total participation interest of the sovereign entity group in ABC Pty Ltd is 15 per cent.

Therefore, any dividends paid by ABC Pty Ltd to SWF 1 and SWF 2 will not be NANE income under Division 880.

Example 4.5: Portfolio interest test not satisfied

SWF is a covered sovereign entity that owns 5 per cent of the ordinary shares in Portfolio Company, an Australian resident company. No other member of SWF’s sovereign entity group holds a direct or indirect interest in Portfolio Company.

Portfolio Company has $1 million of paid-up ordinary share capital. It does not have any other classes of share on issue.

SWF holds a profit participating loan issued by Portfolio Company. The profit participating loan is non-share equity for Australian tax purposes under Division 974. The subscription amount for the profit participating loan was $200,000. 

Other than the profit participating loan held by SWF, there are no other non-share equity interests issued by Portfolio Company.

To determine whether the sovereign entity group of which SWF is a member satisfies the portfolio interest test for the purposes of Division 880, SWF must work out the sovereign entity group’s total participation interests in Portfolio Company assuming that the total amount contributed to the company in respect of non-share equity interests were included in the total paid-up share capital of the company. 

SWF would have a total participation interest of (at least) 20 per cent by virtue of its rights to the capital in the company (taking into account the modifications in paragraph 880-105(4)(b)). That is, SWF holds $250,000 of the total capital of $1.2 million.

Therefore, the sovereign entity group of which SWF is a member fails the portfolio interest test and distributions on the profit participating loan and the ordinary shares will not be NANE income under Division 880.

Example 4.6: Influence test not satisfied

SWF is a corporate entity which is wholly-owned by a foreign government. SWF:

•        is fully funded by general tax revenue raised by the foreign government;

•        will ultimately distribute all profits made to the foreign government as dividends; and

•        is a foreign resident for income tax purposes.

SWF has acquired 9.95 per cent of the issued units in ABC Unit Trust. ABC Unit Trust is an Australian resident MIT with a small number of investors.

Under the constituent documents of ABC Unit Trust, any investor who holds issued units of 5 per cent or more is entitled to appoint an individual to an Advisory Board of ABC Unit Trust. The Board of Directors of ABC Unit Trust cannot make certain decisions in relation to the control and direction of the Trust’s operations without the Advisory Board’s approval.

In these circumstances, SWF has influence in relation to the ABC Unit Trust of the kind described in the influence test.

Therefore, any payments made by ABC Unit Trust to SWF will not be NANE income under Division 880.

Example 4.7: Influence test not satisfied

SWF is a covered sovereign entity that has acquired 4 per cent of the issued units of DEF Unit Trust. SWF has engaged an investment manager, IM Co, to manage its investment in DEF Unit Trust.

IM Co has also been engaged as investment manager in respect of a 9 per cent investment in the issued units of DEF Unit Trust by SFFR, a superannuation fund for foreign residents unrelated to SWF.

DEF Unit Trust is an Australian resident MIT with a small number of investors. Under the constituent documents of DEF Unit Trust, an investor holding 10 per cent or more of the issued units is entitled to appoint an individual to an Advisory Board of DEF Unit Trust. The Board of Directors of DEF Unit Trust cannot make certain decisions in relation to the control and direction of the Trust’s operations without the Advisory Board’s approval.

The constituent documents of DEF Unit Trust operate such that IM Co is entitled to appoint an individual to the Advisory Board of DEF Unit Trust (as it is the investment manager of a combined 13 per cent holding of the issued units of the Trust).

In these circumstances, both SWF and SFFR have influence in relation to the DEF Unit Trust of the kind described in the particular influence test relevant to each entity.

Therefore, any payments made by DEF Unit Trust to SWF will not be NANE income under Division 880. In addition, the withholding tax exemption in paragraph 128B(3)(jb) of the ITAA 1936 will not apply to SFFR in respect of interest, dividend and non-share dividend income arising from this investment.

NANE income of a covered sovereign entity — income from consular functions

4.54               An amount of ordinary income or statutory income of a sovereign entity is NANE income if that income arises from the entity’s consular functions. [Schedule 4, item 6, section 880-205]

Liability to withholding tax

4.55               A foreign resident that derives dividends or interest that is paid by an Australian resident generally has a liability to withholding tax in respect of the payment (section 128B of the ITAA 1936). However, a withholding tax liability does not arise in relation to income that is excluded under subsection 128B(3) of the ITAA 1936.

4.56               Therefore, subsection 128B(3) of the ITAA 1936 is amended to ensure that dividend and interest income derived by a sovereign entity that is NANE income is exempt from withholding tax. [Schedule 4, item 2, paragraph 128(3)(n) of the ITAA 1936]

4.57               A sovereign entity may still be subject to withholding tax on dividend and interest income (at the relevant dividend or interest withholding tax rate) that is not NANE income. In this event, income which is subject to withholding tax will be NANE income under section 128D of the ITAA 1936.

4.58               A foreign resident that receives a fund payment from an Australian MIT is liable to MIT withholding tax in respect of the payment (section 840-805). A fund payment that is made to a sovereign entity that is NANE income is not subject to MIT withholding tax. [Schedule 4, item 5, subsection 840-805(9)]

4.59               A sovereign entity will be subject to MIT withholding tax on a fund payment that is not NANE income. In this event, section 840-815 will apply so that the income which is subject to withholding tax is NANE income - as a result, tax will be payable on these amounts at the fund payment withholding tax rates rather than the corporate tax rate.

4.60               An entity may withhold an amount under the withholding provisions in error. For example, an entity may withhold an amount from a payment of interest to a covered sovereign entity that is exempt from withholding tax because of paragraph 128B(3)(n) of the ITAA 1936. In these circumstances, any amounts withheld or paid to the Commissioner in error can be refunded to the covered sovereign entity under Subdivision 18-B in Schedule 1 to the TAA 1953.

Consequential amendments

4.61               Consequential amendments are made to insert guide material into new Division 880:

•        Subdivision 880-A defines several terms that are fundamental to the operation of the Division;

•        Subdivision 880-B provides that a sovereign entity is liable to pay tax;

•        Subdivision 880-C sets out when investment income of a sovereign entity is NANE income; and

•        Subdivision 880-D specifies that income derived by a sovereign entity from consular activities is NANE income.

[Schedule 4, item 6, sections 880-10, 880-50, 880-100 and 880-200]

4.62               Consequential amendments are also made to:

•        modify the table in section 9-1 to add a reference to a sovereign entity — that table lists entities that must pay income tax; and

•        modify the table in section 11-55 to add a reference to sovereign entities — that table lists provisions in the income tax law that make amounts NANE income.

[Schedule 4, items 3 and 4, sections 9-1 and 11-55]

Application and transitional provisions

4.63               The amendments to codify and limit the scope of the sovereign immunity tax exemption apply to the 2019-20 income year and to later income years. [Schedule 4, item 7, section 880-1 of the IT(TP)A 1997]

Transitional rules to protect existing investments

4.64               Transitional rules apply to protect income and gains from existing investments of a sovereign entity for which the Commissioner provides a tax exemption under the doctrine of sovereign immunity.

4.65               These transitional rules ensure that there is no immediate adverse impact on sovereign entity for investments held at the time the changes were announced.

4.66               To access the transitional rules, the sovereign entity must hold a positive ruling from the Commissioner in respect of an investment asset, which applies at any time between the announcement of the policy (27 March 2018) and the end of the transitional period (1 July 2026).

4.67               In addition, the circumstances relating to the investment asset must not materially change during the transition period. For example, if an existing investment asset (such as a loan) that qualifies for the transitional rules is rolled over before 1 July 2026, the transition period would not cease to apply if all other features of the loan remain the same.

4.68               Under the transitional rules, an amount of ordinary income or statutory income of a sovereign entity is NANE income if:

•        the amount is a return on an investment asset under a scheme;

•        the sovereign entity acquired the investment asset on or before 27 March 2018;

•        on or before that date, the sovereign entity applied for a private ruling in relation to the scheme;

•        before 1 July 2026, the Commissioner gave the sovereign entity a private ruling confirming that the investment asset was not subject to income tax or withholding tax because of the doctrine of sovereign immunity;

•        the private ruling applied during at least part of the period starting on 27 March 2018 and ending before 1 July 2026 (regardless of whether the private ruling started to apply before 27 March 2018, or ceased to apply before 1 July 2026); and

•        the scheme carried out is not materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, paragraphs 880-5(a) to (f) of the IT(TP)A 1997]

4.69               In these circumstances, the amendments will not apply in relation to that investment asset until the later of:

•        the 2025-26 income year; and

•        if the last income year to which the private ruling applies is a later income year than the 2025-26 income year — that later income year.

[Schedule 4, item 7, paragraph 880-5(g) of the IT(TP)A 1997]

4.70               If the transitional rules apply, a sovereign entity cannot deduct an amount for an income year if the amount arises from an investment asset under a scheme. [Schedule 4, item 7, section 880-10  of the IT(TP)A 1997]

4.71               In addition, a capital gain of a sovereign entity from a CGT event that happens in relation to a CGT asset is disregarded if:

•        the capital gain arises under a scheme;

•        the CGT asset is a membership interest, non-share equity interest or debt interest in another entity; and

•        the requirements in paragraphs 880-5(b) to (g) of the IT(TP)A 1997 are satisfied (on the assumption that references in those paragraphs to the investment asset were references to the CGT asset) — that is, broadly, the CGT asset was acquired before 27 March 2018 under the scheme and a relevant private ruling applies in relation to the scheme.

[Schedule 4, item 7, section 880-15 of the IT(TP)A 1997]

4.72               A capital loss of a sovereign entity from a CGT event that happens in relation to a CGT asset in these circumstances is also disregarded. [Schedule 4, item 7, section 880-20 of the IT(TP)A 1997]

Transitional rule to reset the tax costs of assets

4.73               A separate transitional rule applies to reset the tax costs of assets held by a sovereign entity that currently qualify for sovereign immunity. The transitional rule applies if:

•        a sovereign entity acquired an asset (other than money) on or before 27 March 2018;

•        on or before that date, the sovereign entity applied for a private ruling in relation to the asset;

•        before 1 July 2026, the Commissioner gave the sovereign entity a private ruling confirming that the income and gains from the asset were not subject to income tax or withholding tax because of the doctrine of sovereign immunity;

•        the private ruling applied to income and gains during at least part of the period starting on 27 March 2018 and ending before 1 July 2026 (regardless of whether the private ruling started to apply before 27 March 2018, or ceased to apply before 1 July 2026); and

•        the sovereign entity holds the asset on the day that is:

-       the later of 1 July 2026 and the day before the private ruling ceases to apply; or

-       an earlier day that is the day on which the scheme carried out is materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, subsections 880-25(1) and (5) of the IT(TP)A 1997]

4.74               If the transitional rule applies to an asset, then the sovereign entity is taken to have disposed of and re-acquired the asset, for consideration equal to the higher of its market value or cost base immediately before that disposal, on the day that is:

•        the later of 1 July 2026 and the day before the private ruling ceases to apply; or

•        an earlier day that is the day on which the scheme carried out is materially different to the scheme specified in the private ruling.

[Schedule 4, item 7, subsections 880-25(2) and (5) of the IT(TP)A 1997]

4.75               The reset tax cost for an asset may apply, for example, for the purposes of:

•        working out the amount of a capital gain or capital loss that arises when a CGT event happens to the asset; or

•        if the asset is a revenue asset, working out the amount that is included in, or can be deducted from, the assessable income of the sovereign entity.

[Schedule 4, item 7, subsection 880-25(3) of the IT(TP)A 1997]

4.76               In addition, if the transitional rule applies to an asset, any capital gain or capital loss, or any revenue gain or revenue loss, that is made because of the deemed disposal is disregarded. [Schedule 4, item 7, subsection 880-25(4) of the IT(TP)A 1997]

 

 



Chapter 5          

Regulation impact statement

5.1                   This Regulation Impact Statement covers the package of measures in Schedules 1 to 5 to this Bill.

Background

5.2                   Corporate income tax is currently levied at a rate of 30 per cent for companies with turnover of $25 million or more. Australia relies more heavily on corporate income tax than most other countries. In 2013, Australia’s corporate taxation was 4.9 per cent of GDP, while the OECD average was 2.9 per cent. A relatively heavy reliance on corporate tax has been a consistent feature of our tax system over several decades.

5.3                   Where a foreign investor carries on a business in Australia itself or invests in an Australian business, that activity will typically be run through a company structure with the company subject to corporate income tax on its profits (regardless of whether the business is run directly by the foreign company or through an Australian subsidiary company). Dividends paid by an Australian company to foreign shareholders will not be subject to dividend withholding tax to the extent that the dividends are paid out of the company’s taxed profits (i.e. fully franked dividends). Overall, foreign equity investment is typically subject to tax in Australia at a headline rate of 30 per cent.

5.4                   Unlike companies, Australian trusts are generally taxed on a ‘flow-through’ basis. This means that there is no tax payable at the level of the trust. Rather, the beneficiaries of the trust are taxed on the trust income. For example, if a foreign investor is a beneficiary of a trust which earns Australian business income, the trust itself is not subject to tax but the trustee will generally be required to withhold tax at a rate of 30 per cent on behalf of the foreign investor (assuming the foreign investor is a company). [1]

5.5                   While generally foreigners are subject to tax at 30 per cent on business profits, not all returns on foreign investment in Australia are taxed at the corporate income tax rate.

•        Where a foreign investor invests through a MIT, a lower 15 per cent withholding tax rate is available provided certain conditions are met. This rate applies to rental income and some financial services income. This concessional tax regime was announced in 2008 and was aimed at making the Australian funds management industry more internationally competitive.

•        Where a foreign investor loans money to an Australian business, the returns on that investment — the interest payments — can be claimed by the Australian company as a deductible expense. The foreign investor is typically subject to interest withholding tax of 10 per cent, unless reduced under a bilateral tax treaty or domestic exemption. For example, many foreign pension funds enjoy an exemption from interest withholding tax.

•        Where a foreign investor derives royalty income, (that is, which are fees paid for the use of « intellectual » « property » ), Australia generally charges 30 per cent royalty withholding tax. However, many of Australia’s bilateral tax treaties reduce this rate.

5.6                   In addition, foreign government investors enjoy a general exemption from tax where the investor is not acting in a commercial capacity. In practice, this can mean a sovereign wealth fund with an ownership interest of up to 20 per cent (or possibly more) can in some cases be exempt from interest and dividend withholding taxes, capital gains tax and tax on trust distributions (there is no exemption from company tax). While there is currently no legislative basis for this exemption, the ATO administers this exemption on the basis of the international law doctrine of sovereign immunity.

5.7                   This multiplicity of different tax rates, together with Australia’s relatively high corporate tax rate, has seen a rise in tax structuring focused on converting active trading income (that would normally be taxed at 30 per cent) into interest, rent and other concessionally taxed forms of ‘passive’ income. The ‘stapled structure’ is one such arrangement.

The problem

Stapled structures that create integrity concerns

5.8                   A stapled structure is a specific type of arrangement where two or more entities that are commonly owned (one of which is usually a trust) are legally bound together, such that they cannot be bought or sold separately. Stapled structures create integrity concerns where they are used to fragment an integrated trading business so that a portion of the business profits can access concessional tax rates. If the entire business was held in a single entity, all of the profits would generally be taxed at 30 per cent. 

5.9                   A typical stapled structure, as shown in Figure 1, that converts active trading income to concessionally taxed passive income, is set up as follows.

•        Investors own interests in a trading business (a company) and units in a trust (usually a MIT).

•        The trust holds « property » assets needed to carry on the trading business (generally land and buildings).

Figure 1: A stapled structure

 

5.10               The company carries on a business which derives trading income from customers. It pays rent for leasing the land assets from the trust. It may also pay interest on borrowings from the trust.

5.11               Commercially the trust and company are viewed as a single integrated business (for example, by investors and bank lenders). However, because the trust is legally separate and does not control the company, it is not considered to be carrying on a business (that is, it is considered to be passive).

5.12               As a result, the staple is able to effectively convert a portion of the trading income (in the hands of the company) into passive income (in the trust).

5.13               The trust is not subject to corporate tax. Rather, domestic investors are taxed on their share of the trust’s income at their marginal tax rates and foreign investors are subject to lower withholding tax rates (0 to 15 per cent) on their share of the income.

5.14               The tax advantages for non-resident investors are significant. In the above example, trading income that is converted to rent can access the 15 per cent MIT withholding tax rate (rather than being subject to the 30 per cent corporate tax rate). In the case of a sovereign fund investor the rate can be as low as 0 per cent on the converted income.

Growth and proliferation

5.15               Stapled structures emerged in Australia in the 1980s in the « property » sector. In most traditional « property » staples, the trust invests in assets (for example, shopping centres, office buildings) and earns passive rental income from third parties while the operating company carries on a separate but complementary trading business (for example, « property » development). These stapled structures do not convert active trading income into passive income — passive income is earned from third parties.

5.16               Stapled structures have also existed since the late 1990s in some areas of infrastructure (notably, toll roads) but their use was initially limited. This structure involves the road being held by the trust and then being leased to the stapled company to run the toll road business. The use of trusts overcame corporate law constraints on distributing returns when projects in their early years are cash positive but make accounting losses.

5.17               Prior to 2008, the main tax advantage for investors (both domestic and foreign) from using stapled structures was generally limited to a timing benefit. While the trust was not subject to company tax, the profits from the trust were ultimately taxed in the hands of investors, at their marginal rates. For foreign investors, this typically meant they paid 30 per cent withholding tax on the profits of the trust (for example, on rental income). This was the case for stapled structures in the « property » sector as well as the limited number of rental staples in infrastructure.  

5.18               Since the GFC, a series of factors (both tax and non-tax) have combined to drive significant changes in the use of staples in Australia — with the result that staples are now being used in new ways and in new industries to generate significant tax advantages for foreign investors that are not available to domestic investors.

5.19               The key change was the introduction of a concessional MIT withholding tax rate on passive income (including rents) in 2008. This MIT concession was intended to make the « property » and funds management industries attractive by reducing the 30 per cent tax on foreigners on rental income and some financial services income earned through a MIT (a widely held, passive investment trust). The concessional MIT withholding tax rate is now 15 per cent.

5.20               Existing infrastructure staples became unanticipated beneficiaries of the MIT concession. As the MIT concession applied broadly to rental income from land, it had the inadvertent effect of providing a 15 per cent tax rate to foreign investors in those infrastructure businesses using stapled structures. This opened up the possibility for other land rich infrastructure businesses to argue that it was legitimate for them to also use stapled structures to split their business between a land-holding trust and operating company, and for a portion of their active business income to be converted into rent which was subject to the concessional MIT tax rate. 

5.21               Other factors that have helped drive the recent growth in rental staples include:

•        an increasingly uncompetitive corporate tax rate (of 30 per cent) by global standards;

•        the substantial increase in the value of sovereign wealth funds and foreign pension funds associated with an ageing population in a number of developed and developing countries across the world; and

•        the shift in investor focus away from mining in the aftermath of the recent mining boom along with the desire for stable, high yields in a post GFC, low interest rate environment.

Current and future use

5.22               In the infrastructure sector, almost $50 billion of pre-existing, state owned assets have been privatised using stapled structures in the last six years, purchased by a mix of foreign and domestic investors.

5.23               The use of stapled structures has also expanded into land based industries outside of the « property » and infrastructure sectors, with potential for significant future growth.

5.24               The value of assets in rental staples known to the ATO outside of traditional « property » and infrastructure is estimated to be approximately $5 billion. These staples hold assets like hotels, aged care facilities, renewable energy facilities (wind and solar farms) and agricultural land.

5.25               In addition to the large stock of current stapled structures, there is significant potential for growth that exacerbates the revenue risks into the future. Assets worth hundreds of billions of dollars remain on States’ balance sheets and could potentially be privatised into stapled structures in the future.

Other tax concessions

5.26               Of additional concern to the proliferation of staples is how other tax concessions are used in conjunction with stapled structures to further lower effective tax rates. These include double gearing loopholes, the sovereign immunity exemption and the foreign pension fund exemption, which are explored further below. In addition, MITs have started to be used in new ways to reduce the amount of tax foreign investors pay on Australian trading income, including vertical structures (described below).

5.27               Finally, while the concessional MIT withholding tax rate was intended for use by the funds management industry (with the use of MITs commonplace in the commercial and industrial « property » sectors), the use of these concessions has more recently started to spread to the agricultural land and residential « property » sectors.

5.28               Policies designed to address the revenue risk presented by stapled structures must have regard to these additional tax concessions and emerging structures.

Double gearing loopholes through the thin capitalisation rules

5.29               An entity may be funded by debt or equity. Under Australian tax law, an Australian entity can claim a deduction for expenses incurred in connection with debt, for example interest payments. To prevent excessive debt loading in Australia to reduce tax liabilities, Australia has thin capitalisation rules which prescribe limits on debt that Australian and foreign owned multinational entities can use to fund the Australian operations.

5.30               Generally, entities may claim interest deductions on debt up to the higher of these three limits:

•        Statutory safe harbour debt limit: a set rate of debt that an entity can use to fund its Australian operations (for general entities, currently 60 per cent debt to total Australian assets).

•        Arm’s length debt limit: this limit seeks to benchmark commercial or truly independent debt outcomes for the Australian operations.

•        Worldwide gearing debt limit: allows gearing of the Australian operations to be geared up to the level of the worldwide group.

5.31               Despite these limits, some foreign investors may enter into ‘double gearing’ structures to obtain lower effective tax rates.

5.32               Double gearing structures involve multiple layers of flow through holding entities (that is, trusts and partnerships) each issuing debt against the same underlying asset. This effectively allows an investor to gear higher than what is permitted under Australia’s thin capitalisation limits, and obtain greater interest deductions. This means that more of the underlying profits from the Australian business (as business or trading profits are typically taxed at 30 per cent) can be extracted as concessionally taxed interest income (which would be potentially taxed at 0 or 10 per cent).

5.33               Provisions in the thin capitalisations rules exist to prevent double gearing. These are known as ‘associate entity’ provisions. Associate entity provisions are intended to prevent double gearing by requiring ‘grouping’ of ‘associate’ entities. Under the current rules, entities are grouped where there is an ownership interest of 50 per cent or more. Broadly, these rules look to the underlying assets of the associate entity and allow gearing of up to 60 per cent of those underlying assets, effectively preventing re gearing of the same underlying assets using layers of entities.

5.34               In practice, the associate entity provisions do not currently apply to a wide range of investments because each individual investor will have an ownership interest of less than 50 per cent. For example, an investor bidding on an infrastructure asset as part of a consortium may have an ownership interest of 20 to 40 per cent — meaning they are not subject to grouping under the thin capitalisation rules.

5.35               Example 5.1 shows an example of a double gearing structure.

Example 5.1: Outcome under current 50 per cent or more associate entity test

As Trust holds $300 million of assets, the statutory safe harbour debt limit in this structure should be $180 million (60 per cent of $300 million). SPV Trust 1 and SPV Trust 2 have equity interest levels in Trust of 33.33 per cent each.

As the proportion of the entities’ interest levels are below the current 50 per cent or more threshold, they are not required to group under the thin capitalisation rules.

Through the insertion of the SPV Trusts, the foreign pension funds are able to inject an additional $48 million of debt (despite the level of assets remaining the same) within the structure and still be compliant with the thin capitalisation safe harbour limits. The result is that no debt deductions are denied.

Sovereign Immunity

5.36               Australia provides a unilateral exemption from tax to foreign government (‘sovereign’) investors. No exemption exists in legislation — it is based on longstanding ATO practice.

5.37               The principle guiding this exemption is that foreign governments should not be taxed on income from activities that form part of a government function rather than commercial activities. As such, the ATO generally grants immunity where a sovereign investor cannot influence the decision making of the entity in which it is investing. In practice, investors with ownership interests of up to 20 per cent (or even more) have accessed the exemption.

5.38               The exemption applies to a broad range of income types (for example, interest and dividends, as well as capital gains, distributions from MITs and trading trusts).  However, it does not override company tax.

5.39               In the context of stapled structures, the exemption means no withholding tax is collected on income distributed from a MIT to a sovereign investor.

5.40               Most countries do not provide unilateral tax concessions for sovereign investors, with the exception of the US and the UK. A substantial amount of foreign investment in the infrastructure sector has come from jurisdictions without equivalent unilateral concessions.

5.41               Some countries provide tax concessions for sovereign investors on a reciprocal basis (for example, through tax treaties) but such concessions are generally only for interest. For example, most of the tax treaties Australia has with other countries provide sovereign investors, including sovereign wealth funds, with an exemption from withholding tax on interest. Only two of Australia’s tax treaties, with New Zealand and Switzerland, extend this exemption to both interest and portfolio dividends.

5.42               Importantly, even with these bilateral concessions, sovereign investors from these countries still receive a much greater benefit when they invest into Australia due to our domestic sovereign immunity practice, compared to what Australia’s sovereign wealth funds receive when investing into these countries.

Foreign pension funds

5.43               Australia currently provides a broad unilateral exemption from dividend and interest withholding tax for both government and private sector foreign pension funds that are exempt from tax in their home country. The exemption applies to both portfolio and non-portfolio investments; however, it does not extend to MIT distributions.

5.44               The exemption for interest withholding tax provides an incentive for foreign pension funds to gear their Australian investments as much as possible to lower their Australian tax. Combined with a stapled structure, this exemption can result in foreign pension funds paying little Australian tax on Australian business activities.

5.45               A foreign corporate receiving interest income typically pays 10 per cent interest withholding tax. By comparison, domestic investors would ordinarily pay tax on interest income at their marginal tax rates.

5.46               Most other countries do not provide exemptions for foreign pension funds, other than bilaterally through tax treaties.

Combined effect

5.47               Figure 2 shows how a stapled structure, combined with the double gearing loophole and sovereign wealth fund and foreign pension fund exemptions, result in very low rates of tax for foreign investors.

5.48               Figure 3 shows the effective tax rates that can be achieved by foreign investors using this structure.

 

Figure 2: A stapled structure combined with additional concessions



Figure 3: Conversion of income to access lower rates — illustrative effective tax rates achieved by converting trading income to rent and interest through a staple

 

Agricultural and residential MITs

5.49               As discussed above, income derived through a MIT is eligible for the concessional 15 per cent withholding tax rate. In the context of the agriculture sector, foreign investors can use a MIT (and foreign institutional investors can set up their own MIT) to invest in agricultural land and agribusiness to access lower tax rates on income from the land. This is compared with domestic investors who would pay tax at their marginal rates. The concessional tax rate enables foreign investors to pay more for Australian agricultural land, effectively at the expense of Australian revenue. Similarly, in the context of the residential « property » sector, foreign investors can use a MIT to access lower tax rates on income from residential housing held through a MIT than domestic investors who would pay tax at their marginal rates. The ability for foreign investors to access preferential tax outcomes may also lead to domestic investors being disadvantaged.

Emerging structures

5.50               While the most commonly used way to split up trading businesses has to date been through rental staples in industries with significant land-based assets (such as « property » , infrastructure and agriculture), new structures are now emerging that seek to convert trading income to passive income.  

A vertical MIT structure

5.51               Under Australian tax law, widely held trading businesses operated through trusts are generally taxed as companies. If, however, a trading trust is not widely held, it is taxed on a flow through basis but cannot obtain the MIT concession (because it carries on a trading business). In these circumstances, there will generally be a 30 per cent withholding tax on distributions made to foreign investors (other than interest, dividends and royalties).

5.52               Some foreign investors interpose a MIT on top of the trading trust in order to access the MIT concession for trading income. Even though the MIT concession was intended to apply to passive investment income, the untaxed income from the trading trust can be funnelled through the MIT to access the 15 per cent tax rate provided the MIT does not control the trading trust. These vertical MIT structures are being used by some foreign investors to hold interests in Australian trading businesses.

5.53               Vertical MIT structures can be used even where the business is not land rich.

Figure 4: A vertical MIT structure

 

The double trust structure

5.54               Instead of an operating company being stapled to a flow-through trust, two trusts are stapled together. The asset trust works in the same way, that is, it holds the land-based assets. The difference now is that certain non-resident investors are able to achieve flow-through taxation on the operating entity’s income too with the benefit of accessing tax treaty benefits or sovereign immunity.

5.55               The ownership of this structure is designed to ensure that the stapled trading trust does not attract the operation of tax rules which treat widely held trading trusts like companies for tax purposes. Rather, withholding tax, at the rate of 30 per cent must, prima facie, be withheld from any distributions to non-residents. A key tax benefit in this example is that sovereign immune investors pay zero withholding tax on both distributions by the asset trust as well as the trading trust.

Figure 5: A double trust structure

Objectives of government action

5.56               If unaddressed, the use of stapled structures and associated tax concessions for passive income could have significant implications for Australia’s corporate tax system. It is also likely that stapled structures can evolve into further areas that cannot currently be foreseen. Government action to address this issue seeks to balance the following objectives:

•        to protect revenue and improve the integrity of the corporate income tax base;

•        to ensure Australia retains globally competitive tax settings;

•        to provide a more level playing field between domestic and foreign investors; and

•        to increase certainty for businesses, investors, ATO and the Foreign Investment Review Board, such that they can make informed decisions and invest with confidence.

Policy options

5.57               The following options were considered to address conversion of trading income using stapled structures.

•        Option 1: Status Quo

•        Option 2: Prevent trading income from accessing 15 per cent MIT rate

•        Option 3: Close double gearing loopholes in the thin capitalisation rules

•        Option 4: Limit the sovereign immunity tax exemption

•        Option 5: Limit the foreign pension fund tax exemption

•        Option 6: Prevent income from agricultural land from accessing 15 per cent MIT rate

•        Option 7: Prevent income from residential housing accessing 15 per cent MIT rate

•        Option 8: Package options 2, 3, 4, 5, 6 and 7 together

Option 1: Status quo

5.58               Under this option, no law changes would be made to address stapled structures. Instead, the ATO would continue to administer the existing law with respect to these structures.

5.59               In January 2017, the ATO released Taxpayer Alert TA 2017/1 Re-characterisation of Income from Trading Businesses , which outlined its concerns with stapled structures and warned that the general anti-avoidance provisions (Part IVA of the ITAA) might apply.

5.60               The general anti-avoidance provisions in Part IVA are designed to protect the integrity of Australia’s income tax system by giving the Commissioner power to take action against schemes that have been entered into for the sole or dominant purpose of obtaining a tax benefit.

Option 2: Prevent trading income from accessing 15 per cent MIT rate

5.61               This option involves applying a final MIT withholding tax at the corporate tax rate on ‘fund payment’ distributions from a MIT to a foreign investor, to the extent the distribution is sourced from a cross staple payment (to prevent rental staples) or distribution from a trading trust (to prevent vertical MIT structures).

5.62               The 30 per cent MIT withholding tax rate would not apply to cross staple dividends, interest or royalties (if any). Dividends, interest and royalties are not within the scope of the MIT rules and are, by default, subject to withholding tax at the rates of 30 per cent, 10 per cent and 30 per cent respectively, but are significantly reduced under Australia’s tax treaty network.

5.63               This option would neutralise the tax benefits obtained by foreign investors using rental staples, by subjecting cross staple payments to the company tax rate. Domestic investors continue to pay marginal rates and would not be impacted by the change.

5.64               It would not impact any third party income derived by the MIT as it is purely targeted at conversion of trading income through cross staple payments.

5.65               There are circumstances when cross staple payments do not convert trading income. For example, there may be commercial arrangements where the operating entity receives rent from third parties and this is merely ‘passed through’ to the trust. This is most common in the traditional « property » sector. Requiring these staples to restructure in order for the trust to receive these third party rents would create compliance costs, without raising revenue. For this reason, an exemption would be made for cross staple payments that involve a mere ‘pass-through’ of third party rent.

5.66               This option would also not apply where 5 per cent or less of the gross income of the trust relates to cross staple payments. This would lower compliance costs for entities that have some cross staple payments but where trading income conversion is not central to the structure. 

5.67               Arrangements in existence on the date of announcement would be given a seven year transition period. This is aimed at managing the impact on existing investments. Given the long life of infrastructure assets, a 15 year transition period for existing infrastructure staples would be given. However, in order to access transitional relief, entities would need to comply with stricter rules around the pricing of cross staple payments.

5.68               Treasury consulted stakeholders on other mechanisms to neutralise the tax benefits of rental staples. These included:

•        denying the company a deduction for the cross staple payment; or

•        imposing a trustee tax on the cross staple payment at the corporate tax rate.

5.69               The trustee level tax would be refundable to domestic investors (in the same manner as company tax is refundable to domestic shareholders through the dividend imputation system) but would act as a final tax for foreign residents. By comparison only foreign investors are subject to MIT withholding tax. The key advantage of the trustee level tax compared to Option 2 is that it would apply in respect of sovereign wealth funds. Option 2 would not apply to sovereign investors who benefit from the sovereign immunity tax exemption in respect of withholding taxes. As the trustee tax is an entity level tax, sovereign investors would not be exempt.

5.70               Denying a deduction for cross staple payments would entail double taxation. That is, once at the company level (because the company is denied the deduction) and once in the hands of the investors (who are still taxable on distributions derived from the cross staple payment). Compared to Option 2, denying the deduction would significantly impact domestic investors.

5.71               These alternative mechanisms are discussed further in the next section.

Option 3: Close double gearing loopholes in the thin capitalisation rules

5.72               To address the issue of foreign investors entering into double gearing structures, this option involves lowering the associate entity test from 50 per cent or more to 10 per cent or more for the purposes of determining associate entity debt, associate entity equity and the associate entity excess amount. The lowering of the test would be limited to interests in flow-through entities.

5.73               The thin capitalisation arm’s length debt test would also be clarified to require consideration of gearing against the underlying assets (where an entity has interests in another entity).

5.74               No transitional period would be provided for Option 3 as it closes a clear technical loophole in the law.

Option 4: Limit the sovereign immunity tax exemption

5.75               To prevent sovereign investors from accessing 0 per cent tax rates on trading income, the sovereign immunity tax exemption could be legislated and tightened.

5.76               Under this option, a sovereign investor would not be exempt from tax where:

•        it holds an ownership interest of 10 per cent or more in the entity making the distribution or has influence over the entity’s key decision-making; or

•        it receives a distribution of active business income (such as where the income was derived in the course of carrying on a trading business or where income is a fund payment from a MIT derived from a cross staple payment).

5.77               To manage the impact on existing investment, a general seven-year transition period would apply to existing arrangements with a positive ruling from the ATO. The ATO’s tax rulings on sovereign immunity are limited to 10 years, so a seven-year period will cover existing sovereign investments for most if not all of the life of existing approvals. For any sovereign investors that have been issued a private binding ruling by the ATO on sovereign immunity that expires beyond the seven year period, the transitional period would extend to cover the duration of the ruling.

Option 5: Limit the foreign pension fund exemption

5.78               Under this option, the domestic exemption for foreign pension funds would be limited to interest and dividend income derived from an entity in which the foreign pension fund has a portfolio-like interest, that is, holding an ownership interest of less than 10 per cent and does not have influence over the entity’s key decision-making.

5.79               To manage the impact on existing investments, a seven-year transition period would apply to existing arrangements.

Option 6: Prevent income from agricultural land from accessing 15 per cent MIT rate

5.80               Under this option, the tax law would be amended so that agricultural land can still be held in MITs, but would be subject to a MIT withholding tax rate at a rate equal to the top corporate tax rate on income from these investments (including rental income and capital gains).

5.81               To manage the impact on existing investments, a seven-year transition period would apply to existing arrangements.

Option 7: Prevent income from residential housing accessing 15 per cent MIT rate

5.82               Under this option, MITs will be able to hold investments in residential housing that is held primarily for rental purposes, however distributions derived from investments in residential housing that are not used to provide affordable housing would be subject to a MIT withholding tax rate at a rate equal to the top corporate tax rate.

5.83               To manage the impact on existing investments, a ten-year transition period (to 1 October 2027) would apply to existing arrangements.

Option 8: Packaging options 2, 3, 4, 5, 6 and 7 together

5.84               Because staples combine a number of different tax settings to deliver low tax rates to foreign investors, this option involves targeting the use of stapled structures through Option 2 but also adopting the options that address broader incentives for converting trading income into passive income (Options 3, 4, 5, 6 and 7).

Impact analysis and regulatory costing analysis

Option 1: Status Quo

Investment impact

5.85               Stakeholders have reported that the current level of uncertainty about the application of Part IVA to stapled structures may be having an adverse impact on investment, with investors seeking greater certainty before making decisions in the current environment.

Revenue impact

5.86               While Part IVA may apply to stapled structures, this result is not certain. In the meantime, staples remain widely in use with more being established on a regular basis.

5.87               If unchecked, the use of stapled structures will continue to grow rapidly, expanding in existing areas and evolving to new, land-based sectors.

5.88               This could have significant implications for Australia’s tax revenue base. Currently, hundreds of millions of dollars in revenue are being forgone due to staples and associated tax concessions for passive income. If unaddressed, this could rise to be in the order of billions of dollars.

5.89               The use of rental staples could result in the unintended emergence of a dual corporate tax system that taxes foreign investors in land rich industries at rates anywhere between 0 and 15 per cent. Meanwhile, investors in other industries remain subject to the 30 per cent corporate tax rate, and domestic investors face their marginal tax rates of up to 47 per cent (including the Medicare Levy). This creates a tax bias in investment decisions, potentially drawing capital away from more productive industries, including, for example, businesses that are knowledge based and/or research and development intensive, rather than land rich.

Compliance costs

5.90               The ATO has yet to test in court whether Part IVA would apply to a stapled structure.

5.91               While Part IVA is determined on a case by case basis, a decision by a court that Part IVA applies to a particular staple would likely cast doubt over a wide range of stapled structures. If this were to happen, it would cause considerable uncertainty and likely force entities to restructure with little forward notice.

5.92               Even in the absence of a court decision, the uncertainty about the application of Part IVA to these structures gives rise to compliance costs as investors engage closely with the ATO to confirm the details of their structuring.

Option 2: Prevent trading income from accessing 15 per cent MIT rate

Impact on existing staples

5.93               This option would affect the value of assets held in staples. If foreign investors face a higher tax rate on returns from these investments, the net present value of the investment will be lower.

5.94               This would not be the case for traditional « property » staples, such as those investing in shopping centres, commercial office buildings and industrial buildings, to the extent they benefit from the exemption for ‘pass-through’ rent. In these staples, the trust owns the land and buildings and rents the « property » to third party tenants — therefore, this third party rental income would retain the 15 per cent tax rate as originally intended in the MIT rules.

5.95               The option includes a seven-year transition period for investments made before the date of announcement (15 years for infrastructure) in order to mitigate the impact on asset prices for those staples that are affected.

Investment impact

5.96               As a result of Option 2, foreign investors will pay appropriate tax on land rich investments because they are prevented from accessing the concessional tax rates for passive income on cross staple payments (which is actually trading income).

•        It will not impact the level of tax paid by domestic investors on land rich investments. Domestic investors will continue to pay tax at their marginal rates.

5.97               This will mean lower returns for foreign investors in the sectors that currently use stapled structures - infrastructure, « property » , agriculture and renewable energy. This could potentially affect some marginal projects.

5.98               A key concern raised during consultation was that the proposed changes may negatively affect the viability of new nationally significant infrastructure projects. An exception for approved economic infrastructure facilities would mitigate this potential impact for approved projects. Such an exception would focus on new — not existing — facilities. That is, it would only be available if the infrastructure facility has not yet been constructed or for significant upgrades that are not yet committed to. This would ensure that the exception facilitates the construction of infrastructure to improve the productive capacity of the economy and support economic growth.

Revenue impact

5.99               As discussed above, hundreds of millions of dollars in revenue are being forgone currently due to staples and associated tax concessions for passive income. If unaddressed, this could create even further risks to revenue, potentially rising to be in the order of billions of dollars. As such, this option would provide significant revenue protection.

5.100           Vertical MIT structures pose a broader risk to the corporate tax base than rental staples because the tax benefits are not constrained to the conversion of rental income from land. This means they can be used in a much broader range of circumstances.

Compliance cost impact

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

3.23

N/A

N/A

3.23

5.101           This option would involve compliance costs for trusts associated with implementing the changes. Trusts that receive cross staple payments will need to identify and separately report these payments to their investors. Trusts that do not receive cross staple income directly may also need to make system changes because there is a chance they may receive this income from other trusts and will need to report it separately to their investors. That said, the implementation costs for this broader population will be lower than those trusts that receive the payments directly, as they will only need to on report information received from other trusts, rather than identify and separate cross staple payments.

5.102           There is also likely to be a low increase in ongoing costs for trusts receiving cross staple payments associated with identifying and reporting these payments separately. MITs who receive this income indirectly via other trusts are not likely to face an increase in ongoing compliance costs, as the onward reporting of this information should be relatively automatic once systems are in place.

Other mechanisms

5.103           As discussed above, Treasury consulted stakeholders on other mechanisms to neutralise the tax benefits of rental staples, including:

•        denying the company a deduction for the cross staple payment; or

•        imposing a trustee tax on the cross staple payment at the corporate tax rate.

5.104           These mechanisms would both have far greater impacts on investors than Option 2 (in particular, they impact on domestic investors that do not benefit from the tax concessions being accessed through staples).

5.105           Under the trustee tax, the tax would be creditable and refundable to domestic investors, akin to domestic investors receiving franking credits under Australia’s dividend imputation system.

5.106           This may give rise to a timing difference between the two taxing points; when the trustee is taxed and when the investor receives the credit. The time-value of money means this lag would put domestic investors in a worse financial position than under Option 2.

5.107           The trustee tax mechanism would also have adverse implications for third party bank financing and asset valuations.

•        In deciding the quantum and pricing of any debt finance, banks compare a project’s cash flows with its interest payments. Imposing a trustee tax would reduce the project’s cash flows, making the project higher risk from a financing perspective. This would in turn result in projects being subject to higher interest payments and potentially reduce the amount of external finance available. This does not occur under Option 2 as banks generally only look at tax paid at the project level, not the investor level. Withholding taxes are considered to be an investor level tax.

5.108           As discussed above, denying a deduction for cross staple payments would create double taxation in the company and trust, and would impact both domestic and non-resident investors. This would likely force existing staples to restructure after the transition period ends. This may mean the trust needs to sell its assets into a new entity, triggering stamp duty, capital gains tax and refinancing costs.

Option 3: Close loopholes in the thin capitalisation rules

5.109           This option closes a clear loophole in the thin capitalisation rules that allows foreign investors to claim excessive debt deductions to lower their effective tax rates.

5.110           While the ATO is aware of these structures being used, there is a lack of data available on the number of double gearing structures in existence.

5.111           The option would not impact on other areas of the thin capitalisation rules or the tax law that use the concept of associate entity.

Investment impacts

5.112           As the option is designed to only target interests in flow-through entities, the lowering of the associate entity test to 10 per cent or more is expected to have a minor impact on investment. The proposal would not be extended to interests in companies or entities taxed like companies as the same double gearing concerns do not practically arise as they are taxed on their profits rather than receiving flow through treatment.

5.113           The proposal would also not affect commercial portfolio investment. These investors are not thought to have sufficient influence over the capital structures of their investments to exploit the double gearing loophole.

5.114           A behavioural response to any changes to the associate entity provisions may be double gearing using the thin capitalisation arm’s length debt amount (also called arm’s length debt test). Legislative and practical uncertainty around the arm’s length debt test has meant it is unclear whether the test is being applied as intended, which may leave open the potential for double gearing and claiming of higher interest deductions.

5.115           Whilst the test currently implicitly addresses double gearing, it is not an explicit requirement. In practice, this may mean that the gearing of the underlying assets is not necessarily inquired into.

5.116           Clarification of the thin capitalisation arm’s length debt test is expected to have a minor impact as a very small proportion of entities rely on the arm’s length debt test.

Revenue impact

5.117           As discussed above, hundreds of millions of dollars in revenue are being forgone currently due to staples and associated tax concessions for passive income. If unaddressed, this could create even further risks to revenue, potentially rising to be in the order of billions of dollars. As such, this option would provide significant revenue protection.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

0.64

N/A

N/A

0.64

5.118           The proposal is expected to result in a low overall compliance cost impact, comprising a low implementation impact and a low increase in ongoing compliance costs.

5.119           The associate entity rules operate mechanically to prevent double gearing by adjusting the asset levels of the investor by the value of the investee. Where the investee (and the underlying assets) has not been fully geared up to the 60 per cent debt to assets safe harbour, the investor can gear against their proportion of the unused debt capacity. In these circumstances, the investor would need to rely on information from the investee to determine this amount.

5.120           With the lowering of the associate entity test to 10 per cent or more, it is expected that more entities will need to seek information from the flow-through entities they invest in to justify their debt levels. It is expected that this would result in a minor upfront compliance cost and would become part of normal practice over time given that entities with equity interests of 10 per cent or more would be able to obtain information.

5.121           In addition, where entities have diversified assets, the debt would only need to be justified and information sought where the entity is close to their safe harbour debt limit.

5.122           The clarification of the arm’s length debt test is expected to result in minimal compliance costs given it is consistent with the original intent of the arm’s length debt test and helps to clarify what is currently implicit.

5.123           This option also has the benefit of building on the existing thin capitalisation rules and methodologies for calculating the thin capitalisation limits, reducing its administrative and compliance burden.

Option 4: Limit the sovereign immunity tax exemption

Investment impacts

5.124           If this option was to apply to existing investments straight away, it could affect asset prices in markets where sovereign investors are a relatively significant source of investment (for example, infrastructure). This is because some sovereign investors will face a higher tax rate on investment returns, reducing the net present value of the investment, meaning they are willing to pay less for an asset.

5.125           The option includes a seven-year transition period for investments made before the date of announcement. This would mitigate the impact on asset prices.

5.126           In future, the higher levels of Australian tax paid by sovereign investors may reduce the prices they are willing to pay for Australian assets. In the infrastructure sector, this could reduce the price state and territory governments receive for privatised infrastructure assets as foreign government investors are key participants in the market for long-lived stable assets. In other markets, such as the « property » market, it is possible that lower returns for sovereign investors may mean some marginal projects will need to look to alternative sources of funding.

Revenue impacts

5.127           As discussed above, hundreds of millions of dollars in revenue are being forgone currently due to staples and associated tax concessions for passive income. If unaddressed, this could create even further risks to revenue, potentially rising to be in the order of billions of dollars. As such, this option would provide significant revenue protection.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

0.32

N/A

N/A

0.32

5.128           Custodians are likely to be making distributions rather than the underlying investment entities. Generally, a sovereign investor qualifying for the exemption would notify the distributing entity, or its agent, of its qualification for the exemption and provide evidence to this effect. This is because it is the distributing entity that is responsible for collecting the withholding tax. Entities that are affected by this option would be those that make distributions that would no longer be exempt.

5.129           Sovereign investors who previously qualified for the exemption but no longer would under this option would need to update any distributing entities of their change in tax status once the seven-year transition period has expired. This will result in a minor one-off compliance cost associated with updating records.

5.130           Sovereign investors are also likely to engage the services of tax consultants to assist them to assess whether their existing investments qualify for an exemption under the new rules. This is likely to result in one-off purchase costs for sovereign investors with investments in Australia.

5.131           That said, this option should reduce ongoing compliance costs for sovereign investors. Previously, sovereign investors could only benefit from the exemption if they sought and received a ruling from the ATO. By clarifying the operation and scope of the exemption in law, this option would allow sovereign investors to self-assess their tax position instead.

Option 5: Limit the foreign pension fund tax exemption

Investment impacts

5.132           The application of this change to existing investments straight away could affect asset prices in markets where foreign pension funds are a relatively significant source of investment. The seven-year transition period would mitigate this impact. In future, the higher levels of Australian tax paid by foreign pension funds are likely to reduce their desire to invest in some marginal projects, which may need to look to alternative sources of funding.

Revenue impacts

5.133           As discussed above, hundreds of millions of dollars in revenue are being forgone currently due to staples and associated tax concessions for passive income. If unaddressed, this could create even further risks to revenue, potentially rising to be in the order of billions of dollars. As such, this option would provide significant revenue protection.

5.134           Restricting the exemption to interest and dividends paid on portfolio investments will mean that foreign pension funds with significant ownership interests in Australian businesses must pay interest and dividend withholding taxes. This would also help to ensure Australia collects a fair share of tax on economic activity that occurs in Australia.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

0.49

N/A

N/A

0.49

5.135           The compliance impact would be similar to that described for Option 4 above. Custodians rather than the underlying investment entities are likely to be making distributions to foreign pension funds. For foreign pension funds and these distributing entities there would be a minor one-off compliance cost associated with updating records. For foreign pension funds, there would also likely be one-off purchase costs associated with engaging the services of tax consultants to assess how their existing investments are affected by the changes.

5.136           Some foreign pension funds may be able to access other withholding tax exemptions. For example, those available under tax treaties or the domestic exemption for syndicated loans.

Option 6: Prevent income from agricultural land from accessing 15 per cent MIT rate

5.137           As a result of Option 6, trusts holding agricultural land will no longer get the benefit of the concessional MIT withholding tax rate, instead they would be subject to MIT withholding at the top corporate tax rate on fund payments relating to agricultural land made to foreign investors.

5.138           Practically this would mean that foreign investors holding agricultural land through MITs would face a withholding tax at a rate of 30 per cent rather than 15 per cent on income (rent and capital gains) from agricultural land. For domestic investors, this means they continue to be taxed on income from MITs at their marginal rates and continue to enjoy the commercial benefits associated with flow through treatment of MITs.

5.139           Agricultural land that is held in smaller family trusts will continue to have the flexibility to access the benefits of flow-through treatment from MITs.

Investment impacts

5.140           Some foreign investors will pay a higher rate of tax on agricultural investments (including investment into agribusiness) because they are subject to a 30 per cent withholding tax on income available through a MIT rather than the concessional 15 per cent rate. This proposal will not affect foreign investors who hold agricultural land directly or through a company.

5.141           This option would mean that foreign investors could no longer obtain the concessional MIT rate on rent from agricultural land — whether or not it is leased to third parties. The key impact on the agricultural sector could be expected to be a potential adjustment to the inflated prices that foreign investors would bid for agricultural land. This would mean domestic farmers seeking to acquire new land would not be disadvantaged.

5.142           Although greater investment into agricultural land may be positive, a subsidy for these investments in the form of concessional withholding tax rates leaves revenue increasingly at risk and distorts investment. As land is a relatively immobile asset, it is desirable for tax to be extracted on investments in Australian land.

Revenue impacts

5.143           This option would mean that foreign investors pay tax on returns from agricultural land held in a MIT at a 30 per cent withholding tax rate, rather than at a lower 15 per cent withholding tax rate.

5.144           As such, adopting this option would help protect revenue, particularly in the future.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

0.03

N/A

N/A

0.03

5.145           After the end of the transition period, MITs that hold agricultural land will be subject to a 30 per cent withholding tax rate. This will involve some one-off compliance costs associated with understanding the change in the withholding rate and re-evaluating operations as a result of the higher withholding rate. As the change involves only an adjustment to the withholding rate, the additional compliance costs would be minor.

Option 7: Prevent income from residential housing accessing 15 per cent MIT rate

5.146           Under Option 7, trusts investing in residential housing (except for affordable housing) will not get the benefit of the concessional MIT withholding tax rate, but would be subject to MIT withholding at the top corporate tax rate.

5.147           Practically this would mean that foreign investors in a MIT that invests in residential housing (other than affordable housing) will be subject to withholding tax at a rate of 30 per cent rather than 15 per cent on distributions (from rent and capital gains) derived from investments in residential housing. Domestic investors continue to be taxed on distributions through MITs with these investments at their marginal rates and continue to enjoy the commercial benefits associated with flow through treatment of MITs.

Investment impacts

5.148           Some foreign investors will pay a higher rate of tax on investments in residential housing because they are subject to a 30 per cent withholding tax rate on income received through a MIT rather than the concessional 15 per cent rate. This proposal will not affect foreign investors who hold residential « property » directly or through a company.

5.149           As foreign investors would be subject to a higher tax rate, the key impact is expected to be a potential adjustment to the prices that foreign investors are willing to pay in this sector.

5.150           As all MITs investing in residential housing will continue to enjoy the commercial benefits associated with having MIT status, it is not expected that significant investment barriers would arise between different types of residential housing, as long as the purpose of the investment is to derive rent, such as build-to-rent. Investment in affordable housing will continue to be incentivised by a concessional 15 per cent MIT withholding tax rate.

Revenue impacts

5.151           The revenue impacts for this option are estimated to be unquantifiable.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

0.05

N/A

N/A

0.05

5.152           After the end of the transition period, MITs that hold residential « property » (other than affordable housing) will be subject to a 30 per cent withholding tax rate. This is expected to result in a low one-off implementation impact associated with understanding the change and re-evaluating operations in light of the change, as well as a low ongoing compliance cost impact. As the change involves only an adjustment to the withholding rate, the compliance cost will be minor.

Option 8: Packaging options 2, 3, 4, 5, 6 and 7 together

5.153           This option has the advantage of targeting the use of stapled structures, emerging structures and the broader incentives for converting trading income into passive income.

Investment impacts

5.154           In the packaging of these options, the investment impacts of Options 2, 3, 4, 5, 6 and 7 (as discussed earlier) remain applicable.

5.155           This option will ensure that domestic investors are not disadvantaged when competing for investment under the current tax settings. As mentioned above, the current settings allow foreign investors to access tax rates of 0 to 15 per cent on income from investments in land rich industries — a concession not available to domestic investors who ordinarily would be taxed at their marginal rates.

5.156           The option could potentially affect some marginal projects due to the higher withholding tax rate faced by foreign investors. Although tax can have a significant impact on investment decisions, tax is only one of many factors that investors consider in their investment decisions. There are a multitude of other factors that investors consider, such as the regulatory, political and social environment of their investment. Any impact of this option on the viability of new nationally significant infrastructure projects is mitigated through the 15 year exception being provided for new and approved economic infrastructure facilities.

Revenue impacts

 

2017-18

2018-19

2019-20

2020-21

2021-22

Revenue

($m)

$30.0m

$80.0m

$125.0m

$165.0m

5.157           This option is estimated to have a gain to revenue of $400.0 million over 2018-19 to 2021-22.

5.158           Moreover, the package protects the revenue base going forward. It was mentioned above that hundreds of millions of dollars in revenue are being forgone currently due to staples and associated tax concessions for passive income and if left unaddressed, further risks to revenue, potentially rising to be in the order of billions of dollars, could result. Consequently, the comprehensive nature of this option would address these current and future revenue risks in a more far-reaching manner, thereby providing the greatest opportunity for revenue protection.

5.159           As most of the options comprising Option 8 include transitional periods, it is anticipated that this option would provide significant revenue protection going forward following conclusion of the transitional periods.

5.160           The option to prevent residential housing MITs accessing the 15 per cent concessional tax rate is estimated to have an unquantifiable impact.

Compliance costs

Average annual regulatory costs (from business as usual)

Change in costs ($m)

Business

Community organisations

Individuals

Total

Total, by sector

4.76

N/A

N/A

4.76

5.161           The compliance costs of the package encompass the compliance costs of Options 2, 3, 4, 5, 6 and 7. The package overall involves a low compliance cost impact, comprising a medium implementation impact and a low increase in ongoing compliance costs.

5.162           A regulatory offset has not been identified. However, Treasury is seeking to pursue net reductions in compliance costs and will work with affected stakeholders and across Government to identify regulatory burden reductions where appropriate.

5.163           The net benefits derived from the significant revenue protection and removal of distortions provided by the package would outweigh concerns about increased complexity and compliance costs, as well as the potential impact on investment.

Consultation plan

5.164           Treasury has undertaken significant consultation, including several rounds of public and targeted consultation.

5.165           A consultation paper examining the conversion of trading income derived through the use of stapled structures was released on 24 March 2017. This paper sought stakeholder views on potential policy options in relation to stapled structures, the taxation of real « property investments and the re-characterisation of trading income. The consultation period ran for four weeks and closed on 20 April 2017.

5.166           There was strong engagement from the community; roundtables were held across Sydney and Melbourne, and submissions were received from over 50 stakeholders.

5.167           Treasury met with a range of stakeholders including industry groups, stapled entities, investor groups (pension funds and sovereign wealth funds), and their advisers.

5.168           On 2 May 2017, the Treasurer issued a media release noting that the timeline for the review was extended to allow more time for consultation and to formulate relevant options that minimise unintended consequences.

5.169           Treasury undertook a second round of targeted consultation with stakeholders in July 2017.

5.170           On 27 March 2018, the Government announced it would address the tax integrity risks posed by stapled structures and similar arrangements through a package of measures, that is, adoption of Options 2, 3, 4, 5 and 6.

5.171           On 17 May 2018, the Government released for public consultation a first tranche of exposure draft legislation and draft explanatory material that would give effect to Options 2, 3, 4 and 5. The consultation period closed on 31 May 2018. The consultation provided an opportunity for stakeholders to make submissions on implementation issues related to the draft legislation and to help limit any unintended consequences.

5.172           On 28 June 2018, the Government released a paper outlining the conditions stapled entities must comply with to access the infrastructure exception and the transitional arrangements. The consultation period closed on 12 July 2018. The consultation allowed feedback to be sought from interested parties on the proposed rules to inform the development of the legislation to give effect to the conditions. Exposure draft legislation and draft explanatory material to give effect to the conditions was released for public consultation from 7 August 2018 to 14 August 2018. This consultation enabled interested parties to provide feedback on the detail of the legislation and ensure it aligned with the intent of the policy.

5.173           On 26 July 2018, the Government released for public consultation the second stage of exposure draft legislation and draft explanatory material that would give effect to Option 8. The consultation period closed on 10 August 2018. The consultation provided an opportunity for interested parties to consider draft legislation that had been revised to reflect the feedback received in the public consultation on the first tranche of draft legislation.

5.174           The Government undertook public consultation on exposure draft legislation from 14 September 2017 to 28 September 2017 on changes relating to residential housing MITs, which included clarification that MITs could not acquire investments in residential housing, except affordable housing. The purpose of the consultation was to seek feedback to ensure the draft legislation achieved the policy aims.

5.175           Following consultation on this draft legislation as well as the feedback received following announcement (as part of the package announced on 27 March 2018) of the measure to prevent investments in agricultural land from accessing the 15 per cent concessional MIT withholding tax rate, the policies were refined to neutralise the tax benefits while retaining access to the commercial benefits of MITs. This led to inclusion of the refined policies as part of the release of the second stage exposure draft legislation and explanatory material, which clarified that MITs could hold investments in agricultural land and residential housing (that is held primarily for rental purposes), but income derived from these investments would be subject to a 30 per cent MIT withholding tax rate. The public consultation enabled feedback to be provided on the refined policies and the detail of the legislation.

5.176           Throughout the process, Treasury worked closely with the ATO to identify any implementation issues, integrity concerns and unintended consequences.

5.177           Over the course of the release of the consultation paper in 2017 through to announcement of the package of measures and release of the different stages of exposure draft legislation, Treasury has been engaging with a broad range of stakeholders on the various elements of the package.

5.178           Issues that have been raised during consultations can be broadly categorised as the following, which included:

•        the importance of the length of any transition periods;

•        exclusion of infrastructure and real estate investment from the scope of any changes;

•        the commercial benefits of staples;

•        the potential effect on foreign investment; and

•        technical issues with the draft legislation, which may lead to unintended outcomes.

5.179           Careful consideration was undertaken on the issues raised during consultation, and a number of refinements were made to the measures in the package whilst balancing the desire to protect the revenue base, in particular:

•        the stapled structures review was extended and a number of stages of public consultation were held to allow stakeholders an opportunity to provide feedback on the initial draft legislation as well as revised draft legislation;

•        as the package focuses on neutralising the tax advantages available through a stapled structure, investors can continue to have access to the commercial benefits of staples and are not required to restructure;

•        transitional arrangements have been included for the majority of the elements in the package to minimise the impact on existing investments, with a longer transitional period provided for infrastructure staples (which typically are longer lived investments). Transitional arrangements have not been provided where the change addresses a clear technical loophole in the law;

•        the package allows third party rent passed through a staple to retain access to the 15 per cent concessional MIT rate;

•        the package provides for an exception for Government approved, new nationally significant infrastructure; and

•        a number of technical refinements were made to the legislation to ensure that it achieved the appropriate policy outcome and was publicly released for another round of consultation.

Option selection / Conclusion

5.180           The preferred option is to implement Option 8, that is, package options 2, 3, 4, 5, 6 and 7 together.

5.181           Option 8 is preferred over Option 1 as Option 1 does not provide certainty to investors on the tax treatment of stapled structures given the potential for application of Part IVA (the general anti-avoidance rule). Option 1 may also leave the corporate tax base at significant risk.

5.182           In contrast, Option 8 comprehensively tackles the various tax settings that are combined with staples to deliver low tax rates to foreign investors. Consequently, this option would be the most effective in providing significant revenue protection.

5.183           Moreover, if some of the options are implemented without the others, the reforms will be only partially effective in protecting the corporate tax base.

5.184           For example, adopting Option 2 alone would mean stapled structures are still very attractive for sovereign investors that are currently exempt from withholding taxes under the ATO’s administrative practice. It would also mean sovereign investors could still achieve very low tax rates using double gearing structures and leveraging the interest withholding tax exemption.

5.185           On the other hand, if no action was taken on the conversion of trading income to passive income (Option 2) and only Options 3, 4 and 5 were adopted (the options to address broader incentives for conversion), this would in effect embed a 15 per cent tax rate for foreign investors in certain sectors, effectively creating alternate corporate tax regimes of 15 and 30 per cent.

5.186           In addition, not adopting Options 6 and 7 would leave the sectors around agricultural land and residential housing exposed to the preferential tax outcomes that foreign investors are increasingly accessing in these sectors.

5.187           Option 8 also mitigates the potential impact on investment since it incorporates the transition periods relevant to the options.

5.188           For these reasons, only Option 8 would address the problems identified comprehensively.

Implementation and evaluation / review

5.189           Legislation is required to implement the preferred option, which the Government intends to enact as soon as practicable.

5.190           The majority of the elements of the package, that is Options 2, 4, 5, 6 and 7, will take effect from 1 July 2019.

5.191           Option 3 will take effect from income years commencing on or after 1 July 2018 as the option addresses a clear loophole in the current law which is being exploited. This means the majority of tax returns that are first affected would be lodged in 2020.

5.192           The ATO administers the existing rules that are relevant to the options. It is well placed to implement both the elements of the package and monitor their effects on the behaviour of corporate taxpayers.

5.193           Stapled entities that are under the transitional arrangements and/or are able to access the 15 year infrastructure exception will be subject to certain conditions that they must comply with to access the concessional MIT rate during the transitional period. This will provide safeguards to ensure that entities do not engage in aggressive cross staple pricing during the transitional period or during the 15 year infrastructure exception.

5.194           Those that wish to access the transitional arrangements will be required to make an election. This will enable the ATO to obtain information and monitor the staples that are accessing the transitional arrangements and that are not yet subject to the MIT withholding rate levied at the corporate tax rate. The ATO will also continue to have oversight of the staples that have elected into the transitional arrangements following the conclusion of the transitional arrangements.

5.195           The mechanisms built into the infrastructure exception that will be available for 15 years to new and substantially improved economic infrastructure facilities also provide Treasury and the ATO with a greater ability to monitor the implementation of the exception. As granting of the exception will require approval from the Government, Treasury and the ATO will have full information and clear oversight of facilities that have access to the concessional 15 per cent MIT withholding rate. Assessments of applications for the 15 year infrastructure exception will also be informed by expertise from a range of public bodies involved with infrastructure and will be subject to legislative criteria.

 



Chapter 6          

Statement of Compatibility with Human Rights

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Treasury Laws Amendment (Making Sure Foreigners Pay Their Fair Share of Tax and Other Measures) Bill 2019

Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018

Income Tax Rates Amendment (Sovereign Entities) Bill 2018

6.1                   These Bills are compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 .

Overview

6.2                   Schedules 1 and 5 to Treasury Laws Amendment (Making Sure Foreigners Pay Their Fair Share of Tax and Other Measures) Bill 2019 amend the ITAA 1997, the ITAA 1936 and the TAA 1953 to improve the integrity of the income tax law for arrangements involving stapled structures and to limit access to tax concessions for foreign investors by increasing the MIT withholding rate on fund payments that are attributable to non-concessional MIT income to a rate equal to the top corporate tax rate.

6.3                   An amount of a fund payment will be non-concessional MIT income if it is attributable to income that is :

•        MIT cross staple arrangement income;

•        MIT trading trust income;

•        MIT agricultural income; or

•        MIT residential housing income.

6.4                   Schedule 2 to Treasury Laws Amendment (Making Sure Foreigners Pay Their Fair Share of Tax and Other Measures) Bill 2019 amends the ITAA 1997 to improve the integrity of the income tax law by modifying the thin capitalisation rules to prevent double gearing structures.

6.5                   Schedule 3 to Treasury Laws Amendment (Making Sure Foreigners Pay Their Fair Share of Tax and Other Measures) Bill 2019 amends the ITAA 1936 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by limiting the withholding tax exemption for superannuation funds for foreign residents.

6.6                   Schedule 4 to Treasury Laws Amendment (Making Sure Foreigners Pay Their Fair Share of Tax and Other Measures) Bill 2019 amends the ITAA 1936 and the ITAA 1997 to improve the integrity of the income tax law to limit access to tax concessions for foreign investors by codifying and limiting the scope of the sovereign immunity tax exemption.

6.7                   The Income Tax (Managed Investment Trust Withholding Tax) Amendment Bill 2018 makes consequential amendments to the Income Tax (Managed Investment Trust Withholding Tax) Act 2008 to specify that the MIT withholding rate on income attributable to non-concessional MIT income is 30 per cent.

6.8                   The Income Tax Rates Amendment (Sovereign Entities) Bill 2018 makes consequential amendments to the Income Tax Rates Act 1986 to specify that sovereign entities are liable to income tax on taxable income at a rate of 30 per cent.

Human rights implications

6.9                   These Bills do not engage any of the applicable rights or freedoms.

Conclusion

6.10               These Bills are compatible with human rights as they do not raise any human rights issues.

 




[1] An exception to this is where the trust is a ‘public trading trust’.  These rules seek to prevent large, widely held businesses running trading businesses through a trust. In this case, if the trust carries on a trading business and is ‘public’ (that is, widely held), the trust is taxed like a company.