Last Friday, 27 August 2021, the Government re-released, for public consultation, the exposure draft legislation for the implementation of the tax and regulatory components of the CCIV regime (Updated ED). The Updated ED builds on, and takes into account, the feedback received in respect of, the previous exposure draft legislation released for public consultation in January 2019 (2019 ED).
What is a CCIV?
The key policy objective of the CCIV regime is to enhance the international competitiveness of the Australian fund management market by enabling fund managers to offer investment products to overseas markets using an internationally recognised investment vehicle. Australia's current trust-based funds management market is seen as a barrier to investment by many offshore investors, particularly in jurisdictions where significant cross-border investment is traditionally offered through the use of corporate vehicles.
Under the proposed regime, a CCIV is a new type of company limited by shares, with a public company as a director (Corporate Director). The Corporate Director will have an Australian financial services licence authorising it to conduct the affairs of the CCIV through sub-funds. The CCIV structure is designed as an alternative to a trust-based managed investment scheme.
CCIVs may issue shares and debentures to investors and each type of security issued by the CCIV must be referable to only one sub-fund of the CCIV.
Each sub-fund is a distinct and protected part of the CCIVs business which must be segregated from any other sub-fund in the same CCIV. Accordingly, each investor will obtain an 'interest' in a specific sub-fund of the CCIV.
However, a sub-fund does not have a separate legal personality. This means the sub-funds cannot enter into contracts, or acquire, hold and dispose of assets or liabilities in their own name. Instead, these acts will be done by the CCIV on behalf of a sub-fund. The assets and liabilities of the CCIV are to be allocated to each sub-fund of the CCIV in accordance with the allocation rules under the Updated ED.
Returns are made to investors in a manner similar to that of any other company. CCIVs will be able to pay dividends, redeem redeemable preference shares and reduce share capital.
Tax treatment of CCIVs
The tax treatment of CCIVs is intended to align with the existing tax treatment for 'Attribution Managed Investment Trusts' (AMITs). The tax outcomes for an investor in a CCIV sub-fund are intended to be the same as those of an investor in an AMIT. This includes 'flow through’ treatment and concessional withholding tax rates on certain distributions to eligible foreign investors notwithstanding that the CCIV is a corporate entity and pays a legal form dividend.
In order to access these benefits, the sub-funds of a CCIV need to meet the AMIT tax eligibility criteria which broadly include:
- passing the widely held test;
- not being closely held;
- being limited to carrying on passive income activities; and
- being an Australian resident.
Similar to MITs, CCIVs will be subject to the public trading trust (PTT) provisions which, if failed, can result in the sub-fund being taxed as a company.
Broadly, the PTT provisions require 'public' unit trusts to only carry on passive activities, such as investing in land for rental income purposes. That same test will apply to the CCIV's sub-fund.
Key changes to CCIV regime in Updated ED
In relation to the CCIV tax framework, there are two key changes between the Updated ED and the 2019 ED:
- a trust relationship is deemed between a CCIV, the business, assets and liabilities referable to a sub-fund, and the relevant class of members, for the purposes of all taxation laws, with the result that taxation laws apply to the CCIV sub-fund trust rather than to the CCIV as a company; and
- the CCIV tax regime does not introduce a specific administrative penalty in relation to the 'unders' and 'overs' regime.
Key change 1 – Deemed trust relationship
Position under 2019 ED
As outlined above, the underlying tax policy objective is for the tax treatment of CCIVs to mirror the existing tax treatment of AMITs.
Under the tax framework in the 2019 ED, CCIVs were to be treated as a separate company in relation to each sub-fund. Each sub-fund that was able to meet eligibility requirements which were based on the current AMIT provisions (see above) was to be taxed on a flow through basis like an AMIT.
A sub-fund that failed to meet the eligibility criteria (including as a result of breaching the PTT provisions) was to be taxed as a company for the remainder of its existence. Further, the deemed sub-fund company was not a franking entity, meaning distributions made to members of the sub-fund were unfrankable. This resulted in a risk of ongoing double taxation, given the investment income would be taxed at both the sub-fund and investor level.
This double taxation risk could be seen by fund managers to be a significant disincentive to structure an investment as a CCIV as opposed to a traditional MIT, given:
- the eligibility requirements and PTT provisions are applied annually for a MIT, meaning failure to satisfy the rules does not taint the investment on an ongoing permanent basis;
- a MIT that is taxed as a company as a result of failing the PTT provisions is entitled to frank distributions to investors, reducing the risk of double taxation;
- closely held MITs not subject to the PTT provisions are taxed as a trust (e.g. flow through vehicles), rather than a company that is not a franking entity; and
- whilst the 2019 ED did provide an ability for an excluded sub-fund to roll out of a CCIV, in most cases a rollover would be uncommercial given the associated difficulties (e.g. obtaining approvals and refinancing) and likely transaction costs (e.g. transfer duty and GST leakage).
Position under Updated ED
The Updated ED appears to address this issue by deeming each CCIV sub-fund to be a separate trust for tax purposes.
The deeming principle overrides how the existing tax laws would ordinarily treat a CCIV (as a company) and its members (as shareholders in a company) and has the effect that:
- the assets, liabilities and business referable to a sub-fund are treated as a separate unit trust (to be known as a 'CCIV sub-fund trust');
- the CCIV is treated as the trustee of the CCIV sub-fund trust; and
- the members of the CCIV are treated as the beneficiaries of the CCIV sub-fund trust.
As with the 2019 ED, to access flow through tax treatment and concessional withholding tax rates, a CCIV sub-fund trust must satisfy all requirements for determining AMIT eligibility as specified in Divisions 275 and 276, subject to some specific modifications to account for the particular nature of the CCIV regime.
Importantly, one of these modifications is that in determining a CCIV sub-fund trust's eligibility to be an AMIT, the 'irrevocable choice to elect to be an AMIT' requirement has been removed. This means a CCIV sub-fund trust that meets the AMIT requirements must be taxed as an AMIT and cannot choose to be taxed as a MIT under Division 275.
Where a CCIV sub-fund trust fails to meet the AMIT eligibility criteria, it will either be taxed in accordance with general trust provisions (under Division 6) or as a company under the PTT provisions in Division 6C (if it carries on or controls a trading business in a relevant income year). In contrast to the position under the 2019 ED, a CCIV sub-fund taxable as a company under the PTT provisions should be eligible to frank distributions to members of the CCIV.
We observe that where concepts are 'deemed' for tax purposes, this inevitably introduces an element of uncertainty about the interaction of that concept with existing rules. One only has to look at aspects of the tax consolidation regime as an example. Nevertheless, addressing the double tax risk is a welcome addition and the deeming rule appears to be the simplest method by which the core objective of aligning the tax treatment of CCIVs with AMITs can be achieved.
Key change 2 – Removal of unders and overs penalty
Given the difficulties experienced by trustees of MITs in obtaining information to allow them to calculate, and report to the ATO and investors, the income and net income of the trust within the required reporting deadlines each financial year, amounts reported to the ATO and investors are often based on estimates. This inevitably results in revisions being required to ensure that the estimated amounts initially reported are updated to reflect the correct amounts.
The unders and overs regime in Division 276-F was designed to address the difficulties and administrative burden that would otherwise be experienced by MITs and investors where variances occur between reported and actual amounts. Broadly, the regime allows AMITs to address variances in reported amounts in the year of discovery rather than requiring them to issue revised statements to members, which can subsequently result in the need for members to lodge amended assessments.
Under the regime, if the under or over is the result of an intentional or reckless disregard of the law by the trustee, the trustee may be liable to pay an administrative penalty.
The attribution sub-fund trust under the CCIV regime is able to apply the 'unders and overs' regime to reconcile variances in the same way as an AMIT.
Under the 2019 ED, the Government proposed to broaden the administrative penalties in the unders and overs regime by introducing a new culpability threshold of 'failure to take reasonable care'. This drew heavy criticism from stakeholders on the basis that Treasury was departing from the bargain that was struck following detailed and lengthy negotiations between Treasury, the ATO, the tax profession and other stakeholders regarding the appropriate way the integrity of the overs and unders regime was to be maintained.
Such a change would be expected to increase the penalty exposure risk of CCIVs and trustees of AMITs, which in turn would likely result in CCIVs and trustees of AMITs electing to reissue tax statements instead of using the unders and overs regime. The flow on effects of this outcome could result in a higher administrative burden on the ATO in the form of increased processing of amended assessments and the pursuit of individual investors for tax and interest.
For now, it appears that the Government has acknowledged this criticism as the proposed broadening of administrative penalties in the unders and overs regime is no longer a feature of the Updated ED.
Other regulatory changes in Updated ED
For completeness, we note that the core regulatory framework for the establishment of CCIVs as set out in the 2019 ED has been maintained. However, in response to previous consultation, the Updated ED incorporates several changes including:
- Provide greater flexibility in the CCIV regime for the use of custodian and depositary services: An independent depository is no longer required for retail CCIVs. All CCIVs have the option to appoint a depository or custodian as a matter of commercial practice or in accordance with other regulatory requirements. This change aligns the CCIV regime to the current requirements for managed investment schemes in Australia.
- Facilitate the listing of a retail CCIV with one sub-fund on a prescribed financial market in Australia: A retail CCIV with only one sub-fund will be able to be listed on a prescribed financial market (such as listing platforms like the ASX). This was initially prohibited under the previous exposure draft legislation, although the previously proposed regime did allow quotation of securities in a CCIV on other platforms such as ASX's AQUA platform for managed funds and structured products. The Government has indicated it will consider further the listing of retail CCIVs with more than one sub-fund following establishment of the CCIV regime.
- Facilitate cross-investment between different sub-funds of a CCIV: A CCIV may acquire, in respect of one sub-fund, shares that are referable to another sub-fund of the CCIV. This was initially prohibited under the previous exposure draft legislation. Shares acquired by a sub-fund and referable to another sub-fund are held as an asset for the first sub-fund, and the CCIV acquires rights as a member of the second sub-fund of the CCIV. The Government has foreshadowed that a restriction on circular investment is proposed to be set out in the Corporations Regulations 2001 (Cth) from establishment of the regime on 1 July 2022. The Government has specifically sought feedback on the appropriateness of this proposal and the restrictions to be set out in the Regulations.
What is missing in the Updated ED?
Removal of AMIT restructure rollover
Whilst the changes represent another positive building block to the CCIV regime, there are still further matters that need to be addressed from both a tax and non-tax perspective, such as the ability to transition existing managed investment scheme structures into a CCIV.
The 2019 ED tax framework contained proposed restructure rollover provisions for situations where sub-funds were to be rolled out of CCIVs or where existing MITs were to be transitioned into a CCIV sub-fund structure. These provisions are a notable absence from the Updated ED. The Explanatory Material to the Updated ED is silent on this issue.
The CCIV regime is targeted at providing an attractive form of investment to investors who are unfamiliar with, or would not otherwise invest in, a trust structure. Investors of existing MITs have already overcome this hurdle. Accordingly, we would not expect there to be a large number of existing MITs eager to immediately transition into a CCIV structure. Additionally, we note that:
- the taxation of a CCIV structure simply mirrors the existing taxation regime for MITs meaning there is no incentive to restructure from an income tax perspective;
- fund managers of existing MITs are likely to be familiar with the tax and regulatory regime which provides more certainty over a new unfamiliar CCIV regime; and
- restructuring an existing scheme is likely to trigger adverse State and Territory based duty consequences, noting many MIT/AMIT structures have real property holdings.
With this in mind, and given the targeted commencement date of 1 July 2022 for the CCIV regime, it is perhaps not surprising that the rollover provisions relating to the restructure of existing MITs into a CCIV have been parked, for another day.
Further, as the double tax risk associated with a sub-fund of a CCIV failing to meet the flow through eligibility requirements has been addressed by the changes to the tax framework, the removal of the provisions that proposed to introduce a rollover to a sub-fund transitioning into a separate corporate vehicle are also not surprising.
Clarification of control
Unfortunately, the Government has not taken the opportunity to provide clarification on the concept of control of a trading business which would be useful in the context of both CCIVs and AMITs (and any public unit trust).
Will the CCIV regime achieve its purpose?
It is too early to say whether CCIVs will become prevalent in the Australian fund industry.
Whilst the approach under the 2019 ED may have resulted in CCIVs being unattractive to fund managers as compared to trust based alternatives due to the tax risks associated with non-fulfilment of flow through eligibility requirements, this no longer appears to be the case.
For non-resident investors that are familiar with a corporate regime, and would not otherwise invest in a trust based scheme (perhaps some based in Europe), a CCIV should provide a viable investment option that achieves the same tax outcomes that would be achieved in a managed investment scheme environment.
In practice, we expect that MITs/AMITs will remain as the preferred investment structure, at least in the short to medium term.
While the proposed CCIV tax framework appears to achieve parity between CCIVs and MITs/AMITs, advisers are familiar with the existing tax and regulatory regime for MITs/AMITs. The fact that the MIT/AMIT rules have been in force for some time, with interpretational guidance in the market from the ATO, and the absence of a deeming rule under trust based schemes provides more certainty as to how the structure will be treated from a tax perspective. With this in mind, and faced with an unfamiliar and complex regulatory regime, we expect advisers to continue to prefer MITs/AMITs for the foreseeable future, unless particular investors have an aversion to a trust based scheme.
In an environment of seemingly endless bad news, we end on a positive note - these developments are a positive step. A step in the right direction.
Hoping they're introduced, further developments to the rules should only increase their attractiveness and use.
This article first appeared in Thomson Reuters Weekly Tax Bulletin Issue 36, 3 September 2021.