What the tax reform headlines have missed?

When it comes to business tax reform most of the headlines have been about capital gains tax (CGT) reform, accelerated depreciation and the lower corporate tax proposal.

When it comes to business tax reform most of the headlines have been about capital gains tax (CGT) reform, accelerated depreciation and the lower corporate tax proposal.

What has been missed however is the decision by the Government to create a special savings instrument which will be known as a collective investment vehicle (CIV).

IFSA’s retail and wholesale investment managers have resoundingly supported this measure. The harbinger of the CIV came earlier this year. On 22 February, the Treasurer announced that the Government would continue past practice in allowing income earned in retail managed investments such as CMTs and listed property trusts to be passed through the fund and then to be taxed in the hands of individual investors.

In the months following the Treasurer’s decision, IFSA members and many other organisations made submissions on how this pass through would work. One of the sticking points in this phase of the Ralph Review was whether wholesale investment trusts would also have pass through. To give pass through to retail trusts, it was argued, and not to wholesale trusts would lead to the perverse result of not having pass though at all — as many of the retail trusts use underlying wholesale trusts.

It is worth reading pages 535-546 of the rather weighty Ralph tome as they include a well argued case for having retail and wholesale CIVs. Two key reasons are given for flow though:

? Cash flow detriment compared to direct investors; and

? The need to avoid a messy refund system to allow those in managed funds to acquit the rate of tax on the vehicles with their actual marginal rate.

The decision to uphold the passing through income for managed funds is more than just that. One of the millstones around the neck of the managed investment industry has been the tax structure under which it has operated. That structure grew out of the taxation of private trusts generally.

Unfortunately for this industry, whenever a government decision has been made to crack down on tax avoidance schemes arising from these private trusts, there has been collateral damage inflicted on the managed investment products offered by IFSA members. Trust loss and trading in franking credits legislation are but two of the unwelcome reforms of recent times.

In addition, there has been a reluctance on the part of policy makers to reform the taxation of managed investments for fear of private trusts also taking advantage of any beneficial changes. In this regard, the restructuring of managed investments has been especially problematic. This became quite apparent when special legislation was needed to allow managed investment schemes to roll over under the Managed Investment Act (MIA).

Retail CIVs will have their own taxation characteristics which will be quite distinct from the taxation of private trusts. The later will not have pass through standing.

To be eligible for CIV status, a CIV will need to be widely held, that is it will have more than 300 members and 20 or fewer will not hold more than 75 per cent of the interests in the profits, capital or voting rights.

This covers the retail CIVs but what about the wholesale component of the industry? A wholesale fund will be one which has all its interests held at all times in either retail CIVs, complying super funds (other than excluded funds), approved deposit funds (ADFs), pooled superannuation trusts (PSTs), life company statutory funds of life insurance businesses and friendly societies.

If the fund cannot satisfy this 100 per cent test, there is a lower threshold provided the fund is registered under the Managed Investments Act (MIA) and 75 per cent of the assets are held by pooled investment entities listed above.

Obviously, these arrangements will not suit every fund or fund manager. Almost all exercises of this type experience boundary issues. Furthermore, there are some concerns that the 300 member threshold for widely held schemes may be too high and could erect a barrier to entry that lessens competition.

IFSA is currently working with the Treasury to progress these matters. In the event that solutions to all the problems cannot be found, CGT relief will need to be granted to those funds forced to restructure.

The CIV announcement was not the only good news for the industry. We also welcome the decision to pass through tax preferred income in property trusts. Similarly, the decision to give CGT relief both in the fund and at the investor level is a very welcome development.

Richard Gilbert is the deputy chief executive officer of the Investment and Financial Services Association (IFSA).