Current rules: Foreign investors are able to access the 15% managed investment trust (MIT) withholding tax rate on MIT fund payments derived from distributions by the "trust side" of the staple structure. These distributions may represent receipts from both third parties or cross staple payments such as rent or interest.

Proposed changes

MIT fund payments derived from cross staple rental payments and certain cross staple financing arrangement payments (not interest) will be subject to withholding tax when paid to the non-residents at the company tax rate (currently 30%), rather than the current concessionary rate of 15%.

In addition, the higher withholding tax will apply to MIT fund payments derived from distributions received from a trading trust.

Exceptions

There are three main exceptions to this increased MIT withholding rate:

1. 15 year exemption for nationally significant infrastructure assets approved by the Government;
2. rent received by the operating entity from third parties passed through as rent to the trust;
3. where small proportions of gross income of the trust relate to cross staple payments.

Why

The Government states this measure “neutralises the tax benefits of stapled structures by preventing foreign investors from accessing the 15 per cent MIT rate on active business income”.

Thoughts

This will impact a large number of MITs operating in a stapled structure and drive the effective tax rate of the stapled structure towards the corporate tax rate (especially for those structures which have features to which the changes proposed in Elements B, C and D are directed to).

Many will not have small proportions of their income that come from the cross staple rental payments (and so not fall within the second exception), and nationally significant infrastructure assets are in a limited pool (the third exemption is quite specific).

Given this, there will be some focus on whether the rent across the staple represents 'rent' received from third parties. This will involve a legal property law analysis. Particular examples to be considered will include student accommodation, retirement villages, hotels, storage facilities and car parks.

Current rules

Parties are considered associates under the thin capitalisation rules if they have common control interests of at least 50%.

Proposed changes

Lower the thin capitalisation associate entity test (for the purposes of determining associate entity equity and associate entity debt) from 50% or more to 10% or more for interests in flow-through entities.

Exceptions

No exceptions.

Why

The Government is aware of heavily geared stapled structures circumventing associate rules via layers of flow-through entities. The gearing of these structures often far exceeds that which would be available if the thin capitalisation rules applied on the overall 'group'.

Thoughts

This practice will effectively be shut down and will potentially have relevance beyond stapled and MIT structures. This practice would have been able to be undertaken outside of the MIT and infrastructure space. While the present proposal is limited to interests in flow-through entities, it is an open question whether the lower test may be applied for all thin capitalisation purposes in the future

Current rules

Withholding tax exemptions are available for foreign pension funds, lowering interest and dividend withholding to nil.

Proposed changes

Limit the withholding tax exemptions for foreign pension funds on interest and dividend income derived from an entity in which the fund has a portfolio-like interest (ie holds an ownership interest of less than 10% and does not have influence over the entity’s key decision-making).

Exceptions

No exceptions.

Why

The Government considers that the current exemption is not in line with global practice and creates the incentive for foreign pension funds to “gear their Australian equity investments using investor debt to lower their overall Australian tax on the investment”.

Thoughts

The longstanding exemption for foreign pension funds currently operates for all Australian investments, and is not specific to stapled structures or MITs. While this has been captured in the stapled structure review as there are a large number of these funds investing in Australia through MITs, this is clearly a decision around the long standing policy setting now being considered too generous. The Government notes that Australian pension funds do not always have the same benefit when they invest in foreign jurisdictions. Perhaps an approach could have been taken to allow the exemption in full in Australia where the corresponding jurisdiction also provides a similar exemption.

Current rules

Sovereign investors investing in ‘non-commercial’ activities are provided with a broad tax exemption as a matter of ATO practice, rather than legislation.

Proposed changes

A legislative framework for the sovereign immunity tax exemption will be created.

Exceptions

The sovereign immunity tax exemption will be restricted to situations where sovereign investors have an ownership interest of less than 10 per cent and do not have influence over the entity’s key decision making. In addition, the exemption will not extend to distributions of trading business income from trusts (including where the trading income has been converted to rent through cross staple payments).

Why

The Government recognises that most countries do not provide foreign sovereign investors with broad tax concessions, and presumably wishes to bring Australia closer in line with global practice.

Thoughts

Again, this is not an announcement specific to staples or MITs. Codifying this exemption is welcomed and has been on the agenda for years. Having said that, the proposal does seem stricter than the ATO practice that has been adopted. For example, it was well understood that the 10% interest was not a bright line test. It will also be interesting to see what level of influence is accepted as this law develops, and whether the legislation will provide details of types of influence which are specifically accepted or not accepted. We have heard of recent examples where the ATO has stated that the ability to appoint a director to the board was enough to fail the sovereign immunity test. If a narrow interpretation is adopted, the exemption will have very limited application as foreign investors generally seek to have measures in place to protect their investments (e.g. appointment of a director).

Current rules

Foreign investors can currently access the 15 per cent MIT rate on rent and capital gains derived by a MIT from agricultural land.

Proposed changes

Prevent rent from agricultural land from qualifying as eligible investment business income. As a result, investing in agricultural land will result in the trust becoming a trading trust for MIT purposes.

Exceptions

No exceptions.

Why

The Government wishes to “level the playing field” to ensure that foreign investors to not receive favourable tax treatment compared to local investors.

Thoughts

It seems a decision around agricultural land being seen as used in an active business has driven this measure. There is an argument that agricultural land can be separated as can any other, however it appears that this is viewed as a 'splitting' of an active business from a passive asset.