Division 6C was introduced in 1985 to tax public unit trusts like companies unless they restricted their activities to essentially passive investment activities (‘eligible investment business’). Stapled structures arose to allow the combination of trading activities, in a company, with associated non-trading assets in a trust to which Division 6C does not apply.
Since around 2007, the Coalition and Labor Federal Governments successively amended tax laws to encourage foreign investment into Australian real property assets with a series of reforms and new laws concerning management investment trusts (MIT). The flow through characteristics of a trust coupled with low withholding tax rates on distributions caused MITs to become a favoured vehicle for foreign investment into Australia (often in combination with a stapled company).
Stapled structures are often used to hold infrastructure assets and real property.
In recent years the Australian Taxation Office (ATO) became concerned that the MIT tax rules and stapled structures have been utilised to ‘fragment’ a business or to ‘recharacterise’ the nature of a business’s trading income so that its income is taxed at a lower rate on a flow-through basis.
Taxpayer Alert 2017/01
On 31 January 2017, the ATO released Taxpayer Alert 2017/1 (TA) that highlighted what the ATO saw as inappropriate use of stapled structures to avoid tax. In the TA, the ATO was especially concerned with the proliferation of stapled structures when it came to investments outside the traditional asset classes (that is, private infrastructure or trading businesses with a significant amount of real property assets).
The ATO view was that a common ‘misuse’ of a stapled structure in Australia involved a corporate tax entity which carries on ‘active income earning’ business activities and a related trust. In this scenario, the trust would acquire and own real property and lease it, and perhaps also make loans to, the corporate tax entity. The rent and interest paid is assessable income of the trust and deductible by the corporate tax entity. Typically, most of the profits from the structure would end up in the trust (via the rent and interest) and taxed on a flow-through (pre-tax) basis in the hands of unit holders with foreign unit-holders subject to withholding tax (usually no more than 15%) on the distributions.
The ATO was concerned that by using this structure, an integrated business was artificially divided into two in order to avoid being taxed at the 30% corporate tax rate.
On 24 March 2017, Treasury released a Consultation Paper confirming that the Federal Government intended undertaking a thorough examination of the taxation of investment income derived using stapled structures, focusing on three main issues:
- development of a policy that can deal with existing tax integrity concerns;
- classification of assets that should receive the tax incentives available to certain foreign investors; and
- determining the right framework to deliver these tax incentives.
Announced integrity measures in relation to stapled structures
On 27 March 2018, the Treasurer, Scott Morrison announced the introduction of proposed new integrity measures for stapled structures.
These new measures (see, Details of Package) are intended, the Treasurer said, to preserve the integrity of Australia’s taxation rules and to protect the corporate tax base and include five proposed changes to the tax laws:
A) Preventing active business income from accessing the 15% MIT rate by increasing the withholding rate to 30% for fund payments derived from cross staple rental payments, cross staple payments made under some financial arrangements such as total return swaps, or where the MIT receives a distribution from a trading trust;
B) Preventing double gearing structures through the thin capitalisation rules (see below);
C) Limiting the 0% withholding tax rate on distributions to foreign pension funds to portfolio-like investments (less than 10% stake) and the foreign pension fund does not have influence over the entity’s decision making;
D) Limiting the sovereign immunity exemption to portfolio-like investments (less than 10% stake) and the sovereign investor does not have influence over the entity’s decision making; and
E) Exclusion of agricultural land from being able to qualify as an ‘eligible investment business’ with the effect that trusts holding agricultural land may not qualify as MITs with consequences including that the concessional MIT withholding rates would not be available (see below).
In particular, we would like to draw attention to measures B) and E) being respectively the proposed amendment of the thin capitalisation rules and the exclusion of a trust holding agricultural land from qualifying as a MIT,.
Amendment of the thin capitalisation rules (Measure B)
Under the current thin capitalisation rules, the amount of gearing to fund the Australian operations of both foreign entities investing into Australia and Australian entities investing overseas is limited and takes into account debt in other entities in which the taxpayer holds (broadly) an interest of 50% or more. The thin capitalisation rules can apply when debt deductions for an entity (including associates) is more than $2 million in a year.
The proposed amendments to the thin capitalisation rules aim, with effect from 1 July 2018, to target structures which use a chain of ﬂow-through entities (such as trusts and partnerships) which each issue debt against the same underlying asset (so called “double gearing” structures). This will be achieved by lowering the thin capitalisation associate entity test from 50% or more to 10% or more for ﬂow-through entities.
Exclusion of agricultural land from qualifying as an ‘eligible investment business’ for a MIT (Measure E)
Under the proposed new measure, ownership of agricultural land will no longer qualify as an ‘eligible investment business’. This means that unit trusts that own agricultural land could be trading trusts as defined under Division 6C and therefore not be eligible for classification as a MIT.
Measures A, C, D and E are to commence on 1 July 2019, but arrangements in existence on 27 March 2018 will have access to a seven-year transitional period (As already noted, Measure B is to apply from 1 July 2018). This means that the earliest changes in relation to Measures A, C, D and E will apply is 1 July 2026. Also, existing economic infrastructure staples will be provided a fifteen-year transitional period with respect to Measure A. This means that the earliest Measure A will apply to existing infrastructure staples is 1 July 2034.
While the media focus on the proposed package of measures announced by the Treasurer has been on foreign investors and the ‘big end of town’, Measure B (thin capitalisation) and, to a lesser extent, Measure E (agricultural land) apply more broadly and can impact on private groups as well as those entities to which the media has focused. We await the next instalment with interest!
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