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Taxation implications

A fund that is a unit trust is generally treated as a flow through vehicle for taxation purposes unless it is characterised as a ‘public trading trust’. To be a public trading trust for an income year, a fund must be a ‘public unit trust’, which typically requires it to have made an offer to the public or to have a minimum number of investors. The ‘trading’ requirement is that the fund must carry on activities other than an ‘eligible investment business’, which are essentially non-passive activities such as property development activities or where property is not held for the primary purpose of deriving rent. Where the fund is a public trading trust as a result of its ownership and activities, it may be treated as a company for tax purposes. This means, amongst other things, the taxable income of the fund will be taxed at the company tax rate, and distributions paid to investors will be regarded as dividends. Such dividends may be franked where paid out of profits which have been taxed.

The dividends (whether franked or unfranked) will be included in an Australian resident investor’s taxable income.

Broadly, if the fund is not a public unit trust and/or only carries on an eligible investment business (such as investing in real property for the primary purpose of deriving rent, stakes in equities or mortgage loans held for investment purposes) it should not be liable to pay Australian income tax or capital gains tax (CGT). This is provided investors are presently entitled to all of the fund’s income in each year. Different tax outcomes may arise depending on whether a fund is an ordinary trust, a managed investment trust (MIT), a Withholding MIT or an Attribution MIT (AMIT).

A. If the fund is an ordinary trust (i.e. not a MIT) then both it and its investors will be taxed under Australian taxation law pertaining to trusts.

A fund will effectively be treated as a flow-through vehicle for income tax purposes if it distributes all its income to the fund’s investors on an annual basis.

It is therefore likely that the fund’s investors will be assessed on the taxable income derived by the fund. This will be based on their proportionate share of the annual income of the fund that is distributed to them in that income year.

A fund’s investors will be required to include their share of taxable income in their Australian income tax return.

It should be noted that the CGT discount that may be available to Australian residents is not available to non-residents.

B. A fund may qualify as a MIT where certain conditions are met. These include that the trust be an Australian resident, not carry on activities other than an eligible investment business, satisfy certain ownership tests, and be operated or managed by an AFSL holder. In relation to the ownership tests, if the fund is a wholesale fund, that would typically require the fund to have at least 25 members, not have 10 or fewer members with at least 75% or more of the interests in the fund, and not have a foreign resident individual directly or indirectly holding 10% or more of the interests in the fund.

If the fund meets the definition of a MIT, there are certain tax advantages that may be available. For example, the trustee may be able to make an election to treat certain fund assets, such as real property, as being held on capital account. This may facilitate access to the CGT discount for Australian resident investors.

If it does not elect into the CGT regime it will, by default, be subject to revenue account treatment on all assets – except for land, interests in land, and rights or options to acquire or dispose of land.  The CGT discount does not apply to revenue gains.

As noted earlier, the CGT discount available to Australian residents is not available to non-residents.

C. A fund may qualify as a Withholding MIT if it –

(i) Is an MIT as per above, and
(ii) Has a substantial proportion of its investment management activities carried out in Australia.

If the fund qualifies as a Withholding MIT, in addition to the tax treatment accorded to a MIT as summarised above, concessional rates of withholding tax may apply to distributions of certain income (fund payments) made to foreign resident investors in the fund.

In broad terms, fund payments include distributions of rental income and capital gains from the disposal of Australian real property. Fund payments should generally be subject to MIT withholding tax of 15% if the investors are residents of countries with whom Australia has an Exchange of Information agreement. Otherwise the withholding tax rate is 30%.

A full list of countries with whom Australia has an Exchange of Information (EOI) agreement may be found on the Australian Taxation Office website: ato.gov.au

D. A fund may qualify as an Attribution Managed Investment Trust (AMIT) if it –

(i) Is a MIT as per above, and
(ii) The members of the fund have clearly-defined rights to the income and capital of the fund.

If a fund qualifies to be an AMIT, it must make an election to apply the AMIT rules. The tax treatment accorded to a MIT will also apply to an AMIT.

However, other taxation benefits may apply if the fund is an AMIT. These include:

  • Ability to allocate taxable income to investors on a fair and reasonable basis
  • Deemed treatment as a ‘fixed trust’ for tax purposes, which may facilitate the flow through of franked dividends and the carry forward of tax losses
  • Statutory ability to deal with income unders and overs in the following year
  • The ability to treat different classes of units as separate trusts.
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