Exposure draft legislation was issued on 19 January in relation to proposed new rules around the look-through treatment for instalment warrants and instalment receipts. This exposure draft is titled Tax and Superannuation Laws Amendment (2015 Measures No 2) Bill 2015: Instalment Warrants.
The purpose of this exposure draft is to amend the Income Tax Assessment Act 1997 to ‘look through’ an instalment warrant and instalment receipt trust so that all income tax consequences associated with the underlying asset of the trust flow through to the investor, and not the trustee.
Under current law there has been uncertainty on whether the bare/holding trust in relation to a limited recourse borrowing arrangement (LRBA) has its own income tax lodgment requirements.
To add to the confusion, there has been some commentary from the Australian Taxation Office that in an SMSF/LRBA arrangement, the superannuation fund may not have an “absolute, indefeasible entitlement to the capital and the income of the trust”. However, in saying this, the long-standing practice has been to ignore the existence of the instalment trust for income tax purposes.
The proposed new law, as stated in the exposure draft, is that the investor of the instalment warrant or receipt is treated as the owner of the asset of the instalment warrant or receipt trust (with some exceptions), instead of the trustee.
This means the trust is ignored and anything that happens to or results from being the owner of the asset, such as receiving dividends and franking credits, affects the investor and not the trustee.
By treating the asset as being an asset of the investor and not an asset of the trust, the amendments ensure the investor stands in the shoes of the trustee for all purposes of the income tax law.
However, these amendments do not operate for certain withholding tax purposes and the tax file number provisions.
It also allows any acts done to the asset by the trustee (such as selling the asset) to be taken to have been done by the investor. As the law currently stands, there has also been confusion on whether a potential capital gains tax (CGT) event may occur on payment of the final instalment. If the SMSF was seen not to have “absolute, indefeasible entitlement to the capital and the income of the bare/holding trust”, then a potential CGT event E5 could occur.
Consequently, the trustee would make a capital gain or realise a capital loss if the market value of that asset had increased or decreased since the time of acquisition by the trustee.
CGT consequences may also apply to the beneficiary’s interest in the trust. The proposed new law treats the SMSF as the owner of the asset from the time the fund acquires the interest in the trust.
These amendments make it clear no CGT event, and therefore no CGT taxing point, happens on payment of that final instalment for the trustee. The proposed new laws also clear up any confusion on whether the interest on the loan for the asset acquired by the bare/holding trust is fully tax deductible.
These look-through provisions make it clear the interest deduction is allowable to the fund.
The exposure draft discusses the proposed treatment for non-superannuation instalment warrants and receipts. However, it also brings LRBAs into the proposed new rules by stating that in order to prevent superannuation funds from being disadvantaged compared with other entities outside the superannuation system, this measure provides look-through treatment for superannuation funds where the arrangement satisfies the requirements under section 67A of the Superannuation Industry (Supervision) (SIS) Act.
The SIS Act requires superannuation funds to use a trust when using a limited recourse facility, which consequently may subject the superannuation fund to a CGT taxing point on payment of the final instalment. Such restrictions are not imposed on entities outside of superannuation.
Therefore, by providing superannuation funds with look-through treatment for any LRBA that satisfies subsection 67A(1) of the SIS Act, this disadvantage is removed.
It is proposed these new rules will be retrospective and apply from the 2008 financial year. This is in line with the introduction of the borrowing rules for SMSFs.
