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2008/09 Federal Budget – impact of the announcements on property investments
- By Daren Yeoh
- Published 14/05/2008
- Moore Property News
- Unrated
The changes announced in the first Budget of the new Labour Government are generally positive and should encourage property investments in Australia (domestically and from abroad). The changes will make Australian Real Estate Investment Trusts (“A-REITs”) more globally competitive and should remove some of the distortionary impact that the current tax laws have on decision making.
This Moore Property News provides Moore Stephens’ insight as to the impact of the 2008 Budget announcements on property investments in Australia, being:
• Changes to withholding regime for Managed Investment Trusts
• Changes to Division 6C Public Trading Trust rules
• Introduction of TOFA 3 & 4
• Changes to the GST margin scheme rules
1. Final withholding tax on managed investment trust (“MIT”) distributions Snapshot:
^ It is anticipated that the proposed measures will receive Royal Assent in the 2007/2008 income year.
* The lower rates apply to a foreign investor who is a resident in a jurisdiction with which Australia has an effective exchange of information (EOI) agreement. The relevant countries will be listed in the regulations. We have set out in Appendix A, the countries which currently have a double tax agreement (which should have the EOI provisions within it) /an EOI with Australia.
Summary of key changes:
The key changes are as follows:
• The new rules will only apply to Australian Managed Investment Trusts (MITs), as defined in the existing tax law;
• The withholding will apply to ‘Fund Payments’ which are broadly Australian source income (other than dividends, interests and royalties – these components remain subject to the existing withholding tax regime) and capital gains on ‘Taxable Australian Real Property’;
• The non-final withholding tax will be (except for the commencement year) replaced with a final withholding tax regime;
• For Non-residents (EOI), the rate of withholding will reduce progressively from 30% to 7.5%. For other non-residents, the withholding rate remains at 30%; and
• Non-residents (EOI) may be able to claim expenses against the Fund Payments in the first (2008/09) income year, by lodging an Australian income tax return and claiming a refund for any excess withholding amount withheld by the MIT. The regime in this year involves a non-final withholding regime.
Historical Background
The proposed changes will enhance the rules introduced in Tax Laws Amendment (2007 Measures No. 3) Bill 2007.
Reminder - which Trusts are subject to the MIT withholding rules?
The MIT rules (and hence the new amendments) apply to trusts which satisfy all the conditions required of an MIT – in broad terms the trust must be:
• an Australian resident for tax purposes;
• a managed investment scheme under the Corporations Law and operated by an appropriately authorised financial services licensee; and
• listed or have 50 or more members; or certain entities (such as a life insurance company, a superannuation fund with 50 or more members; another MIT or a foreign widely held entity) hold units in the trust.
What amounts are subject to the MIT withholding?
The proposed changes cover payments to foreign resident beneficiaries by the trustee that, broadly speaking, are payments of income which would have previously been taxable net income to the non-residents. That is, tax deferred amounts should not be subject to withholding, nor would dividend, interest and royalty payments (as these amounts are ordinarily subject to their own withholding tax arrangements), nor would foreign sourced income and capital gains on assets that are not taxable Australian real property, as these amounts are generally not taxable in the hands of foreign residents.
However, discount capital gains are effectively required to be doubled for the purposes of determining the amount subject to withholding. Given the final withholding regime, this would mean the loss of the CGT discount for eligible foreign investors. It is questioned whether this was the intent of the Government.
Rate of withholding
The rate of the final withholding is set out in the snapshot table above.
The lower withholding rate will make Australian REITs more globally competitive as Australian tax leakage is reduced.
Again, note that the lower rates only apply to residents of countries with an EOI with Australia. Other non-residents will continue to be subject to a 30% withholding rate. This raises the following issues:
• The MIT will need to implement procedures and controls to ensure that the correct withholding rate is applied, depending on the jurisdiction of the unitholder. This will be a challenge for many unit registries;
• Distribution statement formats will need to be amended to reflect the different rates;
• Non-residents may wish to invest into Australian MITs via a country with an EOI in Australia, in order to access lower withholding rates.
Presumably the relevant MIT would be required to apply the concessional rates in these circumstances, as it would be impossible to establish the actual residency of the ultimate underlying unitholder;
• MITs currently estimate their taxable income for the year when making periodic distributions (e.g. quarterly or semi-annual distributions) to unitholders. As the withholding is now a final withholding, the question arises as to whether the expectations as to accuracy of these interim calculations will increase. Depending on the ‘fine print’ of the new legislation, MITs may need to be more accurate with their estimates; and
• Given that the final rate of withholding (for 2011 and onwards) is less than the current rate of withholding on interest payable to non-residents, this may influence the financing structure of inbound investment into MITs.
What happens if the MIT rules do not apply?
If the MIT rules do not apply, then the existing rules relation to taxation of income from trusts apply. This means that the trustee of the trust would remain liable to pay tax by assessment on behalf of a non-resident beneficiary in respect of the beneficiary’s share of the net income of the trust. The applicable rate will depend on the nature of the beneficiary (individual – non-resident marginal tax rates; company beneficiary – 30%, non-resident trustee – 45%).
2. Changes to the public trading trust rules
Background
Division 6C broadly speaking renders a public trading trust liable to tax in its own right in a way basically the same as a company (at the company tax rate). In order to be classified as a public trading trust, the trust must satisfy the definition of both a ‘trading trust’ and a ‘public unit trust’.
A public unit trust is, very broadly, a listed or a widely held trust.
A trust will be regarded as a trading trust for the purposes of these measures if it is:
• a trust that carries on a trading business; or
• a trust that controls, either directly or indirectly, another entity that carries on a trading business.
Under the current law, a trust will not be a trading trust where its activities consist wholly of an ‘eligible investment business’.
An ‘eligible investment business’ is currently defined to include investing in land “primarily” for the purpose of deriving rental income. Also within the definition of eligible investment business is investing or trading in loans, shares, units, bonds, debentures or other similar securities.
The somewhat unforgiving “wholly” condition referred to above has plagued the property funds management since Division 6C was enacted and the announcement in the 2008/09 Federal Budget to provide legislative tolerance for some trading activity within public trusts, whilst overdue, is most welcome.
The Budget announcement is consistent with the changes foreshadowed in the industry consultation paper “Potential changes to the eligible investment rules for managed funds, including property trusts” (released by Treasury in February this year). These changes are intended to allow A-REITs to be more competitive with foreign investment trusts.
Broadly, the Government intends to introduce a 25% safe harbor threshold that allows an A-REIT to earn up to 25% of its gross income (excluding capital gains) from sources other than rent. This replaces the ambiguous terminology of ‘primarily from rent’ and will ease compliance with these rules. These changes will take effect from the date the amending legislation receives Royal Assent.
3. Stage 3 & 4 of TOFA will be re-introduced
The announcement
The Treasurer has confirmed that the rules originally contained in Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007 will be re-introduced. This bill, which lapsed due to the proroguing of Parliament prior to the Federal election, contains a provision for taxpayers to early-adopt the proposed measures from 1 July 2008. This provision will be removed. This means that in general, all taxpayers can only apply the rules from 1 July 2009. This is somewhat unfortunate for those entities for which the TOFA 3 & 4 changes are expected to be advantageous, as the prospect of early adoption was appealing for particular taxpayers.
Whilst there is obviously some lead-time until these rules take effect, we recommend that taxpayers begin early preparation for the adoption of the new rules. There are a number of reasons why early education and preparation is important. Firstly, when the proposed law comes into force, taxpayers may elect to apply the rules to arrangements entered into before the relevant start date (with the opening gains/losses generally spread over four years). Therefore it may be worth structuring arrangements now in anticipation that an election may be made to apply the proposed legislation to them. Secondly, the new regime may impact on accounting policies of the relevant taxpayer and may encourage taxpayers to more seriously consider hedge accounting options under AASB 139 in order to obtain a better tax outcome. To analyse this fully and allow sufficient time for implementation will require some time.
The background
The stated object of the new regime is to more closely align the tax and commercial (i.e. accounting) treatment of gains/losses from financial arrangements and to minimise compliance costs. It seeks to do this by incorporating concepts from the accounting standards into the tax legislation framework and providing flexibility in relation to the calculation of taxable gains or losses from financial arrangements.
The term “financial arrangements” is very broad. In practice, the proposed rules will mainly apply to derivative instruments (whether held for hedging or speculative purposes) and equity instruments (mainly those held for trading where the relevant election is made), but it should not be assumed that its application will be limited to such items.
How to approach TOFA 3 & 4
The suggested approach to implementation of TOFA 3 & 4 is as follows:
Step 1: Work out which transactions are caught
- Step 1a: What is a financial arrangement?
- Step 1b: What transactions within the relevant taxpayer are specifically treated as a financial arrangement?
- Step 1c: What transactions are specifically excluded from the operation of the proposed measures?
Step 2: Understand the tax timing methodologies (there are six in all!) which determine the basis on which gains and losses on a financial arrangement are to be recognised for tax purposes and document the pros and cons of the applicable methodology, having regard to likely tax outcomes of the available alternatives;
Step 3: Decide on the methodology and calculate the gain/loss using the method elected.
Moore Stephens has established a comprehensive framework to enable you to implement your TOFA 3 & 4 project. We are happy to assist you to prepare for the transition into the new rules. The diagram below broadly depicts the Moore Stephens TOFA Project Implementation Steps.
Please contact Daren Yeoh, International Tax Partner at Moore Stephens should you wish to discuss any aspect of TOFA 3 & 4.
4. GST on Real Property and the Margin Scheme – new integrity measures
New rules to protect the intended operation of the margin scheme have also been announced. These measures had been flagged by the previous Government, but implementation had been deferred.
The margin scheme essentially applies GST to the value added to property by a registered supplier over and above the value of the property at the time that the property first enters the GST system. Property may have entered the system by being on hand as at 1 July 2000 or later through a GST-free acquisition.
The sorts of schemes that the new amendments are targeting are contrived arrangements such as the transfer of property within GST consolidated groups in order to increase the base price of the real property before sale to an external market, effectively reducing the margin that GST is applied to. The new measures are expected to impose GST to the value added through the entire supply chain (eg consolidated group).
The exact nature of these amendments remains somewhat vague, but it is clear that the margin scheme provisions will remain a challenging part of the GST regime for taxpayers and authorities alike.
When clear details emerge further advices will be provided.
5. Affordable housing measures
Further incentives for investors to create affordable rental property and individuals to save for a first home have been announced in the Budget. A new National Rental Affordability Scheme has been announced under which the Federal Government will provide $6,000 pa (via refundable tax offsets) for a maximum of 10 years to “complying institutional investors” that construct rental property that is provided at a rate of 20% below the prevailing market rate for the applicable area.
Modifications have also been announced to the First Home Saver Accounts scheme.
Appendix A Countries with DTA/ an EOI with Australia
Countries with DTA with Australia
Countries With EOI agreement with Australia
Antigua & Barbuda
Bermuda
Netherlands Antilles
Please contact Daren Yeoh on (03) 9614 4444 if you want to further discuss any aspect of the Federal Budget.
This Moore Property News provides Moore Stephens’ insight as to the impact of the 2008 Budget announcements on property investments in Australia, being:
• Changes to withholding regime for Managed Investment Trusts
• Changes to Division 6C Public Trading Trust rules
• Introduction of TOFA 3 & 4
• Changes to the GST margin scheme rules
1. Final withholding tax on managed investment trust (“MIT”) distributions Snapshot:
|
|
2008/2009^ |
2009/2010 |
2011 onwards |
|
Existing Rules (current legislation) | |||
|
Withholding Rate |
30% |
30% |
30% |
|
Nature of Withholding |
Non Final |
Non Final |
Non Final |
|
New Rules (as announced in Budget) | |||
|
Withholding Rate - Non-residents (EOI)* - Other non-residents |
22.5% 30% |
15% 30% |
7.5% 30% |
|
Nature of Withholding |
Non Final |
Final |
Final |
^ It is anticipated that the proposed measures will receive Royal Assent in the 2007/2008 income year.
* The lower rates apply to a foreign investor who is a resident in a jurisdiction with which Australia has an effective exchange of information (EOI) agreement. The relevant countries will be listed in the regulations. We have set out in Appendix A, the countries which currently have a double tax agreement (which should have the EOI provisions within it) /an EOI with Australia.
Summary of key changes:
The key changes are as follows:
• The new rules will only apply to Australian Managed Investment Trusts (MITs), as defined in the existing tax law;
• The withholding will apply to ‘Fund Payments’ which are broadly Australian source income (other than dividends, interests and royalties – these components remain subject to the existing withholding tax regime) and capital gains on ‘Taxable Australian Real Property’;
• The non-final withholding tax will be (except for the commencement year) replaced with a final withholding tax regime;
• For Non-residents (EOI), the rate of withholding will reduce progressively from 30% to 7.5%. For other non-residents, the withholding rate remains at 30%; and
• Non-residents (EOI) may be able to claim expenses against the Fund Payments in the first (2008/09) income year, by lodging an Australian income tax return and claiming a refund for any excess withholding amount withheld by the MIT. The regime in this year involves a non-final withholding regime.
Historical Background
The proposed changes will enhance the rules introduced in Tax Laws Amendment (2007 Measures No. 3) Bill 2007.
Reminder - which Trusts are subject to the MIT withholding rules?
The MIT rules (and hence the new amendments) apply to trusts which satisfy all the conditions required of an MIT – in broad terms the trust must be:
• an Australian resident for tax purposes;
• a managed investment scheme under the Corporations Law and operated by an appropriately authorised financial services licensee; and
• listed or have 50 or more members; or certain entities (such as a life insurance company, a superannuation fund with 50 or more members; another MIT or a foreign widely held entity) hold units in the trust.
What amounts are subject to the MIT withholding?
The proposed changes cover payments to foreign resident beneficiaries by the trustee that, broadly speaking, are payments of income which would have previously been taxable net income to the non-residents. That is, tax deferred amounts should not be subject to withholding, nor would dividend, interest and royalty payments (as these amounts are ordinarily subject to their own withholding tax arrangements), nor would foreign sourced income and capital gains on assets that are not taxable Australian real property, as these amounts are generally not taxable in the hands of foreign residents.
However, discount capital gains are effectively required to be doubled for the purposes of determining the amount subject to withholding. Given the final withholding regime, this would mean the loss of the CGT discount for eligible foreign investors. It is questioned whether this was the intent of the Government.
Rate of withholding
The rate of the final withholding is set out in the snapshot table above.
The lower withholding rate will make Australian REITs more globally competitive as Australian tax leakage is reduced.
Again, note that the lower rates only apply to residents of countries with an EOI with Australia. Other non-residents will continue to be subject to a 30% withholding rate. This raises the following issues:
• The MIT will need to implement procedures and controls to ensure that the correct withholding rate is applied, depending on the jurisdiction of the unitholder. This will be a challenge for many unit registries;
• Distribution statement formats will need to be amended to reflect the different rates;
• Non-residents may wish to invest into Australian MITs via a country with an EOI in Australia, in order to access lower withholding rates.
Presumably the relevant MIT would be required to apply the concessional rates in these circumstances, as it would be impossible to establish the actual residency of the ultimate underlying unitholder;
• MITs currently estimate their taxable income for the year when making periodic distributions (e.g. quarterly or semi-annual distributions) to unitholders. As the withholding is now a final withholding, the question arises as to whether the expectations as to accuracy of these interim calculations will increase. Depending on the ‘fine print’ of the new legislation, MITs may need to be more accurate with their estimates; and
• Given that the final rate of withholding (for 2011 and onwards) is less than the current rate of withholding on interest payable to non-residents, this may influence the financing structure of inbound investment into MITs.
What happens if the MIT rules do not apply?
If the MIT rules do not apply, then the existing rules relation to taxation of income from trusts apply. This means that the trustee of the trust would remain liable to pay tax by assessment on behalf of a non-resident beneficiary in respect of the beneficiary’s share of the net income of the trust. The applicable rate will depend on the nature of the beneficiary (individual – non-resident marginal tax rates; company beneficiary – 30%, non-resident trustee – 45%).
2. Changes to the public trading trust rules
Background
Division 6C broadly speaking renders a public trading trust liable to tax in its own right in a way basically the same as a company (at the company tax rate). In order to be classified as a public trading trust, the trust must satisfy the definition of both a ‘trading trust’ and a ‘public unit trust’.
A public unit trust is, very broadly, a listed or a widely held trust.
A trust will be regarded as a trading trust for the purposes of these measures if it is:
• a trust that carries on a trading business; or
• a trust that controls, either directly or indirectly, another entity that carries on a trading business.
Under the current law, a trust will not be a trading trust where its activities consist wholly of an ‘eligible investment business’.
An ‘eligible investment business’ is currently defined to include investing in land “primarily” for the purpose of deriving rental income. Also within the definition of eligible investment business is investing or trading in loans, shares, units, bonds, debentures or other similar securities.
The somewhat unforgiving “wholly” condition referred to above has plagued the property funds management since Division 6C was enacted and the announcement in the 2008/09 Federal Budget to provide legislative tolerance for some trading activity within public trusts, whilst overdue, is most welcome.
The Budget announcement is consistent with the changes foreshadowed in the industry consultation paper “Potential changes to the eligible investment rules for managed funds, including property trusts” (released by Treasury in February this year). These changes are intended to allow A-REITs to be more competitive with foreign investment trusts.
Broadly, the Government intends to introduce a 25% safe harbor threshold that allows an A-REIT to earn up to 25% of its gross income (excluding capital gains) from sources other than rent. This replaces the ambiguous terminology of ‘primarily from rent’ and will ease compliance with these rules. These changes will take effect from the date the amending legislation receives Royal Assent.
3. Stage 3 & 4 of TOFA will be re-introduced
The announcement
The Treasurer has confirmed that the rules originally contained in Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007 will be re-introduced. This bill, which lapsed due to the proroguing of Parliament prior to the Federal election, contains a provision for taxpayers to early-adopt the proposed measures from 1 July 2008. This provision will be removed. This means that in general, all taxpayers can only apply the rules from 1 July 2009. This is somewhat unfortunate for those entities for which the TOFA 3 & 4 changes are expected to be advantageous, as the prospect of early adoption was appealing for particular taxpayers.
Whilst there is obviously some lead-time until these rules take effect, we recommend that taxpayers begin early preparation for the adoption of the new rules. There are a number of reasons why early education and preparation is important. Firstly, when the proposed law comes into force, taxpayers may elect to apply the rules to arrangements entered into before the relevant start date (with the opening gains/losses generally spread over four years). Therefore it may be worth structuring arrangements now in anticipation that an election may be made to apply the proposed legislation to them. Secondly, the new regime may impact on accounting policies of the relevant taxpayer and may encourage taxpayers to more seriously consider hedge accounting options under AASB 139 in order to obtain a better tax outcome. To analyse this fully and allow sufficient time for implementation will require some time.
The background
The stated object of the new regime is to more closely align the tax and commercial (i.e. accounting) treatment of gains/losses from financial arrangements and to minimise compliance costs. It seeks to do this by incorporating concepts from the accounting standards into the tax legislation framework and providing flexibility in relation to the calculation of taxable gains or losses from financial arrangements.
The term “financial arrangements” is very broad. In practice, the proposed rules will mainly apply to derivative instruments (whether held for hedging or speculative purposes) and equity instruments (mainly those held for trading where the relevant election is made), but it should not be assumed that its application will be limited to such items.
How to approach TOFA 3 & 4
The suggested approach to implementation of TOFA 3 & 4 is as follows:
Step 1: Work out which transactions are caught
- Step 1a: What is a financial arrangement?
- Step 1b: What transactions within the relevant taxpayer are specifically treated as a financial arrangement?
- Step 1c: What transactions are specifically excluded from the operation of the proposed measures?
Step 2: Understand the tax timing methodologies (there are six in all!) which determine the basis on which gains and losses on a financial arrangement are to be recognised for tax purposes and document the pros and cons of the applicable methodology, having regard to likely tax outcomes of the available alternatives;
Step 3: Decide on the methodology and calculate the gain/loss using the method elected.
Moore Stephens has established a comprehensive framework to enable you to implement your TOFA 3 & 4 project. We are happy to assist you to prepare for the transition into the new rules. The diagram below broadly depicts the Moore Stephens TOFA Project Implementation Steps.
Please contact Daren Yeoh, International Tax Partner at Moore Stephens should you wish to discuss any aspect of TOFA 3 & 4.
4. GST on Real Property and the Margin Scheme – new integrity measures
New rules to protect the intended operation of the margin scheme have also been announced. These measures had been flagged by the previous Government, but implementation had been deferred.
The margin scheme essentially applies GST to the value added to property by a registered supplier over and above the value of the property at the time that the property first enters the GST system. Property may have entered the system by being on hand as at 1 July 2000 or later through a GST-free acquisition.
The sorts of schemes that the new amendments are targeting are contrived arrangements such as the transfer of property within GST consolidated groups in order to increase the base price of the real property before sale to an external market, effectively reducing the margin that GST is applied to. The new measures are expected to impose GST to the value added through the entire supply chain (eg consolidated group).
The exact nature of these amendments remains somewhat vague, but it is clear that the margin scheme provisions will remain a challenging part of the GST regime for taxpayers and authorities alike.
When clear details emerge further advices will be provided.
5. Affordable housing measures
Further incentives for investors to create affordable rental property and individuals to save for a first home have been announced in the Budget. A new National Rental Affordability Scheme has been announced under which the Federal Government will provide $6,000 pa (via refundable tax offsets) for a maximum of 10 years to “complying institutional investors” that construct rental property that is provided at a rate of 20% below the prevailing market rate for the applicable area.
Modifications have also been announced to the First Home Saver Accounts scheme.
Appendix A Countries with DTA/ an EOI with Australia
Countries with DTA with Australia
|
|
|
|
Countries With EOI agreement with Australia
Antigua & Barbuda
Bermuda
Netherlands Antilles
Please contact Daren Yeoh on (03) 9614 4444 if you want to further discuss any aspect of the Federal Budget.
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