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Economics References Committee
08/04/2015
Corporate tax avoidance

MAKAS, Mr Manuel, Director and Head of Real Estate, Greenwoods & Herbert Smith Freehills

MIHNO, Mr Andrew, Executive Director, International and Capital Markets, Property Council of Australia

MORRISON, Mr Ken, Chief Executive Officer, Property Council of Australia

[16:16]

CHAIR: I welcome representatives from the Property Council. I note that you were a late addition. I especially want to thank Mr Mihno, who was here this morning as well, bright and early, and has gone through a whole day of listening to the Senate hearing. I appreciate that and I appreciate you coming with short notice. Mr Morrison, I invite you to give a very brief opening statement. The committee hearing starts again in Canberra tomorrow and a few people, including the secretariat, have flights they need to catch.

Mr Morrison : No problems. We made a submission to the inquiry. We understand that the inquiry has some questions for us in relation to stapled securities in particular. I will make a few opening statements if I may.

CHAIR: If you can also in doing that explain it.

Mr Morrison : Yes, that is what I am doing. First up it is worth noting that the property and construction industry is currently one of the major drivers of Australia's economic growth. Property construction currently represents 11.5 per cent of GDP—that is about one-ninth of economic activity in Australia at the moment. We employ 1.3 million Australians, which is more than manufacturing and mining combined. Property is actually the largest collective taxpayer, contributing $34 billion in real estate specific taxes alone—that is before you add income tax, GST, corporate tax et cetera. Indeed, the recent tax reform discussion paper notes that taxes on property in Australia comprise around nine per cent of GDP versus an OECD average of around five per cent.

I will talk about property trusts now before we move to stapling. Property economic performance has been achieved in part through the use of efficient tax compliance securitised investments called real estate investment trusts or REITs. Nearly 12 million Australians have investments in REITs either directly or indirectly through their retirement savings vehicles. Australian REITs are simply unit trusts that invest in real property. Australia has been an international leader in developing REITs, which are now common around the world. Australia's property trust rules are designed to help Australians invest in property assets they could not afford to own in their own right, broaden their investment portfolio to reduce the risk from market downturns and to benefit from the market experience and insights of professional asset managers.

Australia does not have a special tax regime solely for property unit trusts. Listed property trusts will typically be managed investment trusts, or MITs, for Australian tax purposes. Under a unit trust, investors pay tax directly on their share of the passive taxable income of the trust. This tax is paid by assessment for Australian resident investors, and that can be as high as 49 per cent, depending on the personal income tax rate of the individual or, secondly, through withholding taxes, for non-Australian resident investors, and that is at tax rates of either 15 or 30 per cent, depending on the country of the non-resident investor. I am happy to talk more about that. This flow-through tax treatment is consistent with common practice among the global REIT regimes around the world. The policy objective here is to put unit trust investors in the same tax position as if they had invested directly in the property themselves. That is a very important, fundamental policy objective.

Turning now to stapled securities, property trusts use a staple structure where they have a mix of activities that need to be separated because they are taxed differently. Passive rental investment activities like property investment—just collecting the rent out of office buildings or shopping centres et cetera—are typically conducted under a trust, with income taxed in the hands of the investor, as I said, up to 49 per cent, depending on the personal income tax rate of the investor themselves. Active trading activities such as development for sale cannot be done in that passive investment vehicle. They need to be done in a company, with the income tax at the company rate of 30 per cent. For Australian REITs, staples are simply a company share and trust unit stapled together. The staple ensures that there is a clear separation between the passive rental income streams, typically in a trust, and the active trading activities, typically in a company. All tax is paid to the government, but the tax on the passive rental income is paid directly by the investor as income tax.

It is important to note that stapled securities exist in other jurisdictions around the world. However, for REITs outside Australia, staples are largely unnecessary, because other countries have regulations which allow investors to achieve the same result using a different structure. Again, I am happy to come back to that in questions. For example, in the USA, REIT staples are unnecessary because US investors can use a taxable REIT subsidiary instead, which separates out the different types of income, using a company subsidiary. That is not a structure that is available in Australia.

Just to conclude, Australia has a robust tax system, and the integrity measures have recently been reviewed. These are in line with standards adopted in other developed countries. For example, the thin capitalisation 'safe harbour' limit has been reduced from 75 per cent to 60 per cent. Australia also has a very broad and effective general anti-avoidance rule, part IVA, which has only recently been further tightened. Australia's tax treatment of property trusts is consistent with international guiding principles for collective investment vehicles and REITs in particular. Both the Australian Board of Taxation and the OECD have recognised the critical importance of having tax flow through collective investment vehicles.

Thanks once again for having us here. I am happy to take any questions you might have.

ACTING CHAIR ( Senator Canavan ): In the absence of the chair, are there any senators who have questions? I have some questions.

Senator MILNE: You go ahead.

ACTING CHAIR: Thank you, Mr Morrison, for your submission. It is very useful. This is a simple factual question, I think. You say there that the net rental income from the managed investment trust, or MIT, flows annually to the investor. Can I just clarify that there is not the ability in these trusts to maintain or retain the earnings from year to year and then pay it out later? The rental income earnt, if you like, in one tax year has to be paid in that tax year to the investor?

Mr Makas : Let me clarify that. You can actually retain, but the law acknowledges that, and tax is paid by the unit holders on the taxable income each year, irrespective of the amount distributed.

ACTING CHAIR: So it is effectively paid and then reinvested?

Mr Makas : It is paid and there are integrity rules around that.

ACTING CHAIR: You do not physically have to do that? You do pay tax on it, basically, every year?

Mr Makas : Yes, every single year.

ACTING CHAIR: There is not an ability to defer tax through the trust fund?

Mr Makas : Correct.

ACTING CHAIR: That is clear. On the REITs, the stapled structure, I am just trying to work out what the policy rationale is for having these vehicles. Couldn't we simply have a property trust as a corporation and with our imputation credit system the trusts of the individual investors would still receive franked dividends and not necessarily need this separated structure. Why do we have this separated structure?

Mr Morrison : I will start and let others take over. The starting point is having equivalent tax treatment to owning property directly. Collective investment vehicles have that equivalent tax treatment, so that if I owned a property directly then I would be paying tax on the passive rental income streams at my personal rate of tax. So the flow-through taxation arrangements for collective investment vehicles are given an equivalent status where the tax is paid by the individual, but it limits that to passive income. So where you have an entity which has active income streams, like development or other active income streams, then that active income cannot be in that trust otherwise it trips the trust over and forces the income to be taxed at 30% company two rate.

ACTING CHAIR: The income from those investments gets taxed at the 30 per cent rate?

Mr Makas : No, the whole entity would then be taxed at 30 per cent.

ACTING CHAIR: Okay.

Mr Morrison : So the stapled structure allows the active income streams to exist within a company and to pay tax at that corporate level of tax rate and the passive income flows—rent, basically—exist in that flow-through tax structure that I described. The rationale for that is that that is a tax equivalent of owning directly. So you start with what is the rationale for a collective investment vehicle and a tax flow-through status. As I said in the opening statement, that is the common international practice. It has been reinforced by multiple reviews at multiple times by successive governments. It is an uncontroversial, well established international policy of having a tax flow-through status there. But in Australia that can only be passive income that is in there.

ACTING CHAIR: How many REITs do we have and what would be the total capitalised value?

Mr Mihno : I do not have that information on me. We can come back to you with that.

Senator KETTER: There has been some suggestion that trust structures, particularly stapled securities, offer opportunity for tax arbitrage in Australia. Would you like to comment on that?

Mr Morrison : We do not see an opportunity for tax arbitrage. Because you have, on the passive income flow side, a tax equivalent status between owning property directly and owning it through a collective investment vehicle, you have equivalency there. The tax is being paid by the unit holder at their applicable rate of tax, which could be up to 49 per cent for an individual. So the tax is being paid. It is not being paid by the trust entity; it is being paid by the individual. The tax on the corporate side is being paid at that corporate level of taxation.

The other thing that is useful to bear in mind the integrity measures which are in place, and I might let Manuel talk to some of those integrity measures which protect that.

Mr Makas : Yes, there are integrity measures and the ATO have been prepared, where they have felt those integrity measures should be invoked, to do that and they are about to be further strengthened as well when we bring through the new MIT rules, which are imminent.

Senator KETTER: In terms of these REIT structures, how does the Australian structure differ from structures in other countries such as the US and the UK where stapled securities are not permitted?

Mr Mihno : To our knowledge, stapled structures are permitted in other countries, but the different regulations, as we pointed out before, mean that stapling may not actually be required; they have a different way of dealing with it. So, for example, in the US, stapling is not required because US trading activities—again, separated out from passive activities—can be undertaken by the taxable REIT subsidiary. In Australia, we have said that we have got tradeable activities that are going to be taxed at 30 per cent and we have got the flow-through passive rental, which is taxed at the individual's rate on the other. You have to keep those separated into different vehicles. In America, all they have said is, 'Just keep track of which incomes are trading and which ones are passive and you can keep them in the same vehicle.'

Senator KETTER: Moving on, do you think there are issues with the transparency of privately held property trusts?

Mr Mihno : It depends what you actually define as 'privately held'. If you are talking about family discretionary trusts, they are not actually within our bailiwick. That is not who we are talking about. When we talk about REITs, we are talking about property unit trusts. These are registered or unregistered managed investment schemes. From that point of view, when we talk about transparency, we see that there is full transparency from the REIT perspective.

If you want to talk about private discretionary trusts, that is an entirely different matter, and it is not really within our remit to talk about those.

Property unit trustees have a fiduciary responsibility, which basically means that their obligations often extend past what you would expect from even directors duties under Corporations Law. We also have extensive and comprehensive reporting obligations. For instance, investors get financial reports that are prepared on the same basis as companies. They get detailed tax statements which provide a breakdown of the types of taxable income they have and that the trusts have generated. The ATO also gets full details of all distributions made to investors, broken down by type of investor and income.

Senator MILNE: I just wanted to get an understanding from you, if we were to do away with the stapled security structure, of what that would mean for income from superannuation.

Mr Morrison : I guess it depends in part on what you replace it with. If you were to replace it with a US style structure, that is possible. It is not something we have done a lot of homework on, but there is some attractiveness in that type of structure. As Andrew was describing, you still allow the different types of income to be taxed in different ways. It would depend on what the regulatory requirements were around that and how onerous that was compared to the existing structure. Certainly, if the government were to change the tax flow-through status of property trusts, that would have an immediate and devastating impact on Australian superannuants and other investors. It would certainly send a very strong signal to the world that Australia was out of step in the way that we treat this sort of investment, and we certainly would be recommending the Australian government and the Australian parliament not go down that path.

Senator MILNE: I was just interested to get a response on that. One of the issues that has come up in the government's white paper is the issue of dividend imputation and that whole system, asking whether we need to create tax neutrality between different asset types—property and other types of capital assets. I wondered whether you had a comment to make about that.

Mr Mihno : From that point of view, we are in the process of canvassing opinions from the industry on this particular issue. However, from our initial reaction, it certainly makes sense for a passive investment income to be flow-through, irrespective of the vehicle. However, if government were to take that and make all companies flow-through entities for all incomes, we are not sure that that would work very well at all. One of the important points to remember about dividend imputation is the fact that, as was pointed out by some of the academics earlier today, it does act as an incentive for companies to pay tax. So it is not really a problem from our point of view; it is an enabler for tax. From that point of view, we will provide further detail on this, but it is too early to say. It depends entirely upon what it is that you are looking at replacing it with. At the end of the day, I think it is more important that, if we are going to look at dividend imputation, we focus on making sure that we do not end up as a double tax or with an unfair treatment. I think that, if you focus on that rather than the integrity measure itself, the integrity will flow from that.

Senator MILNE: Okay, but you will obviously be making a detailed submission in relation to that matter?

Mr Morrison : Correct.

Mr Mihno : In the tax white paper process.

ACTING CHAIR: Thank you, Mr Morrison, and your colleagues. We appreciate your submission. Thank you, everybody, for being here today, including those who have stuck around until the end.

Committee adjourned at 16:35