On 27 March 2018 the Government announced a package of so called ‘integrity’ measures, for stapled structures, and other associated issues.
The Commissioner and the Government like to help justify these measures by saying that they follows consultation, by Treasury over the past year. That doesn’t necessarily mean that the changes are good or even ameliorated.
Introduction to Stapling
‘Public Trading Trusts’ have their tax law ‘net income’ taxed at the corporate rate, under s102S of the ITAA36 (which is in Div 6C of Part III of that Act). Even though trusts may carry on businesses, they can still be taxed as a trust under Div 6 of Part III of the same Act (with ‘pass through’ tax assessment available). However, a Public Unit Trust, that is also a Trading Trust, will be taxed like a company (under Div 6C).
The relevant definitions, however, carried the seeds of what has become ‘stapled structures’. A ‘public trading trust’ must (under s102R) be a ‘trading trust’ (as defined in s102N). It will be such a trust, if it carries on a ‘trading business’ which is defined (in s102M) as “a business that does not consist wholly of an eligible investment business“. Thus, a trust could continue to be taxed, as a trust, if it its activities were limited to those within the definition of ‘eligible investment business’ (in s102M).
In 1985, when Div 6C came in, some public unit trusts were concerned that their activities were not “wholly” eligible investment business, with the result that all of its net income could be taxed, at trustee level, at the corporate rate (rather than being allowed to flow through to unit holders, without being first taxed). And so, any activities that were not clearly ‘eligible investment business’ were hived off to a company, whose shares would be (and could only be) traded with the units (figuratively: ‘stapled’ together). Property Trusts, with say, a management or development arm, still do this. And the Government’s integrity measures are less concerned about these, as their arm’s length revenue, is rent or other investment income.
But soon, trading operations were hiving off their real estate, or other assets, to a unit trust, whose units were stapled to the shares. In this case the company would pay, for instance, rent to the Unit Trust, for the building it occupied. But in this case, the Trust’s ‘eligible investment business’ income is no longer ‘arm’s length’ but, rather, comes from its related trading company. This is what the Commissioner, and now the Government, calls ‘converting’ trading income into ‘eligible investment business’ income. The use of the word ‘converting’ is unfair, of course, because a business could sell its building to an arm’s length party, and rent it back. In no sense has that rent a ‘conversion’ of trading income. In any event, it is stapling arrangements, that ‘convert’ trading income, into investment income (in this sense), that have attracted the attention of these integrity measures.
Initially, the attraction for having stapled structures was obtaining or preserving the ‘flow through’ type of tax treatment, which applies to trusts. But more recently, the Managed Investment Trust (MIT) regime has produced further incentives, which are targeted by the measures. They are explained more fully, in the detailed announcement about these measures (which Treasury released on 27 March 2018, at the same time as the Treasurer’s issued his press release – see links below).
Overview of the Integrity Measures Package
The package of measures address the sustainability and tax integrity risks posed by stapled structures and limit the concessions currently available to foreign investors for passive income. The key elements of the package are:
- applying a final withholding tax set at the corporate tax rate to distributions derived from trading income that has been converted to passive income using a Managed Investment Trust (with a 15 year exemption for new, Government-approved nationally significant infrastructure assets);
- amending the thin capitalisation rules to prevent foreign investors from using multiple layers of flow-through entities (i.e. trusts and partnerships) to convert their trading income into favourably taxed interest income;
- limiting the foreign pension fund withholding tax exemption for interest and dividends to portfolio investments only;
- creating a legislative framework for the existing tax exemption for foreign governments (including sovereign wealth funds), and limiting the exemption to portfolio investments; and
- excluding agricultural land from being an ‘eligible investment business’ for a Managed Investment Trust.
Administrative treatment
These changes (except the thin capitalisation changes), will take effect from 1 July 2019. The thin capitalisation changes will take effect from 1 July 2018.
To balance concerns about the impact on existing arrangements, transitional arrangements of seven years (ordinary business staples) and 15 years (for infrastructure assets) have been included for the majority of the package.
Sovereign investors that have a ruling, from the ATO, on sovereign immunity, for a particular investment, which extends beyond the seven year period, will be able to access the transition period, on that investment, until the expiry of the ruling.
Following the implementation of this policy package, the general anti-avoidance rule will not apply, with respect to the choice, of a stapled structure, to obtain a deduction, in respect of cross staple rent, during the transition period.
Further detail and supporting material
Legislation , to implement these measures, is being developed. Further detail can be gained from the following:
- Press Release – Treasurer’s 27 March 2018 Release announcing Integrity Measures Package.
- Integrity Measures Package – Detailed Announcement.
17.4.18
[ATO website – Stapled Structures Integrity Measures; Stapled Structures Integrity Consultation; FJM; LTN 59, 27/3/18; LTN 72, 17.4.18; Tax Month April 2018]
Study questions (answers available)
- Has the Government announced, changes to the law, to limit tax benefits, associated with stapled structures?
- Did ‘stapled structures’ emerge, when Div 6C was introduced (in 1985), to tax ‘public trading trusts’ at the corporate rate?
- Is an ‘eligible investment business’ part of a ‘trading business’ (for the purposes of Div 6C)?
- Do these proposed changes target arrangements that ‘convert” trading income, into investment income, in the sense that the external income is trading income, and the income derived by the trust is non-arm’s length investment income, paid by its stapled trading associate?
- Is one of the announced changes, a 30% final withholding tax, under the MIT regime, for trust distributions of non-arm’s length rent, paid by the associated trading entity?
- Is one of the announced changes, to abolish the withholding tax exemption, for ‘portfolio’ investments, held by foreign pension funds?
- Will the majority of the changes commence on 1 July 2018?
- Will there be a 7 year transition, for existing stapled structures, that hold infrastructure assets, and a 15 year transition for stapled structures holding other business assets?
