Will the new corporate vehicle for managed funds replace trusts?

By Alexis Kokkinos - September 13, 2017

Treasury has released a new Corporate Collective Investment Vehicle (or CCIV) regime in draft.

In a nutshell, the new regime will allow flow-through taxation using a corporate vehicle for collective investment.  Whether the new regime will replace trusts is likely to be dependent on the final rules.  However, based on the draft there will definitely be some advantages and disadvantages in using a CCIV over a trust for certain sectors.

Documents and consultation

A copy of the documents that have been released by Treasury are contained on their consultation website here.  Pitcher Partners have attended all Treasury consultation workshops and have been intrinsically involved in the consultation process.  Please speak to us further if you require additional information.

Editor’s opinion

The proposed new CCIV regime will allow widely held managed funds to be established using a corporate vehicle rather than using a managed investment trust.  The new regime is proposed to provide flexibility by allowing one to run multiple funds using a single CCIV, through what are referred to as “sub-funds” of the CCIV.  The ability to run sub-funds under a master CCIV is a very attractive option which will provide flexibility, as well as compliance and cost reduction to many fund managers. 

In our view, the CCIV regime is likely to be particularly attractive to debt fund managers and equity based type funds.  However, for other types of funds (e.g. property funds), stamp duty, land tax and income tax risks could inhibit the potential use of these funds as compared to the traditional use of separate trusts.  Accordingly, it is unlikely that the current regime of using trusts will be replaced (unless they are forced to move into the new CCIV regime).  Over time, it will also be particularly interesting to see whether LIC managers consider the use of the CCIV regime.

Finally, in our opinion, we believe that aspects of the current managed investment scheme (“MIS”) provisions contained in the Corporations Act may need to be updated and aligned with proposals contained in the CCIV regime.  For example, by introducing the sub-fund concept to the MIS regime.  This is to ensure that competitive advantages do not occur under one regime as compared to another.

What does the new regime look like?

The structure for a CCIV is broadly similar to that of a MIS.  Under the CCIV regime, a specific corporate entity would be established and registered as a CCIV.  This would be required for both retail and wholesale CCIVs.

A corporate director (“CD”) would be appointed to manage and operate the CCIV, which would provide a similar role to the trustee and responsible entity of a MIS.  A depository would be appointed to provide oversight to the CD, as well as hold the assets on trust for the CCIV (however the appointment would be optional for wholesale CCIVs).  The CCIV would also need to be governed by a single constitution.

One of the most significant new aspects of the CCIV is the proposed ability to create “sub-funds” within the CCIV.  Under this proposal, assets would be held in a sub-fund and investors would invest in one or more of the sub-funds of the CCIV.  These sub-funds are intended to have limited liability, without having legal personality (and therefore effectively treated like a separate fund).  The concept of having sub-funds is exciting, as it will allow fund managers to establish multi-fund structures within one scheme.  The following diagram broadly outlines the proposed CCIV regime.

How will a CCIV and its members be taxed?

The income tax treatment of a CCIV is yet to be drafted.  However, the EM states that it is intended that a CCIV will be treated like a flow-through vehicle provided a number of characteristics are satisfied by the CCIV (e.g. the CCIV is widely held and is a passive entity). 

It is expected that a modified AMIT regime will apply to the CCIV, which means that: (1) each sub-fund would likely be treated as a separate entity; (2) taxable income would be allocated to each member on a fair and reasonable basis based on their membership interests in the sub-fund; and (3) cash distributions will not be taxable to members (but would reduce the cost base of the shares held by the member).  Essentially, this would be similar to the tax treatment of a managed investment trust.

How will the sub-fund concept work?

The sub-fund concept is currently only a draft proposal and it may change after the consultation process.  Under the proposal, the CCIV would issue shares referable to a sub-fund, whereby a sub-fund would have assets and liabilities.  Essentially, this means that investors effectively become members of a sub-fund of the CCIV. The provisions provide for limited liability of a sub-fund, but provide no personal identify.  These core rules essentially treat a sub-fund like a separate MIS (without the need to establish a separate MIS).

This means that liabilities of the sub-fund are intended to be limited to assets of the sub-fund and that there will be a preclusion from using assets of other sub-funds to pay for liabilities of another sub-fund (i.e. limitation on cross contamination). 

As there would be no personal identity, the draft ED currently limits transactions between two sub-funds, or joint ownership of assets between two sub-funds.

What are the benefits of having sub-funds?

The sub-fund provisions will allow for multiple “funds” to be created under one single CCIV (making it easier to establish a number of separate funds under management).  This would also mean that two classes of shares could be issued with respect to a single sub-fund (for example, one in AUD and another in USD, facilitated by hedging arrangements).

While we believe that more flexibility could be created by providing legal identify to a sub-fund and allowing joint ownership of assets, Treasury may be reluctant to make such changes on the basis of providing maximum investor protection under the current proposal in the ED. 

That being said, the sub-fund concept is still exciting, as it has the potential to reduce the compliance costs and complexities of setting up multiple funds.  It will also be a clear differentiating factor as between traditional MIS structures and the proposed CCIV (unless the sub-fund concept is replicated in the MIS regime in the future).

Are there types of funds that the CCIV regime could potentially appeal to?

Under the current proposal, the CCIV regime may appear to be more attractive to traditional types of funds, such as debt funds and equity funds. However, this will depend on the final drafting of the legislation.  For those who manage LICs, the CCIV regime will also provide an alternative corporate investment vehicle which will have its key differences for consideration.

Debt funds

For debt funds, the sub-fund concept (which will provide for limited liability and quarantining for a sub-fund) will reduce the need to create multiple entities to quarantine assets and liabilities.  This could be attractive for regimes such as P2P, as well as having running multiple debt funds within one single scheme (e.g. a first mortgage sub-fund and a second mortgage sub-fund).

Equity funds

For equity funds, the sub-fund concept can also allow for multi-currency funds to be created (e.g. a USD or AUD sub-fund, where USD hedging is undertaking in the USD sub-fund portfolio).  It will also enable multiple equity funds to be established within the one single CCIV, where (for example) a manager will look to operate separate portfolios on behalf of other managed funds.

Property funds

With respect to property funds, we believe that risks associated with the operation of the public trading trust provisions, stamp duty provisions and land tax grouping provisions could potentially create unintended outcomes under a CCIV sub-fund regime.  For example, if one sub-fund derives income that is “ineligible”, it could potentially have implications for other sub-funds. 

Furthermore, the issue of new interests in a CCIV could trigger landholder duty where the CCIV already holds an interest in real property.  The devil will be in the detail once the tax rules are released.

Listed Investment Companies (LICs)

While both an LIC and CCIV will be corporate vehicles, there will be differences in the income tax treatment under the two regimes. 

At a broad level, the LIC model provides for complete accumulation, however does not provide for flow through taxation (other than for franking credits and discount capital gains in very limited circumstances).  Accordingly, discount capital gains and foreign income tax offsets can be lost through an LIC. 

In comparison, a CCIV regime may allow for complete flow-through taxation of character (including franking credits, discount capital gains and foreign income tax credits) and could allow for the accumulation of profits in the CCIV (under the attribution regime).  This may give rise to unfunded tax liabilities at the shareholder level, however a CCIV could potentially look to pay a minimum annual cash distribution of 30% to compensate for this. 

Accordingly, both regimes will have their clear differences and may offer different opportunities for fund managers in the future.

Could a wholesale CCIV be established?

Yes.  A wholesale CCIV would still need to be registered as a CCIV under the proposals, however there would be a lower threshold requirement under the Corporations Act for the operation of the scheme.

A wholesale CCIV would still require a Corporate Director to operate the CCIV, which would need to have an AFSL and would need to be a public company.  This appears to be a big change as compared to the current wholesale MIS regime, whereby the trustee of a managed investment trust may not necessarily need to be a public company or may not require an AFSL in its own right. 

There are also a large number of other obligations (as well as rights) imposed on a wholesale CCIV which would not apply under the current regime applicable to wholesale MIS arrangements.

Is there a key difference in whole schemes for tax purposes?

From a taxation perspective, it may still be preferable to use a MIS arrangement rather than a CCIV, especially for smaller funds.  For example, if a fund only has 20 wholesale investors, it is unlikely to meet the widely held test for AMIT purposes.  Using a unit trust, the fund would still be taxed on a flow-through basis under the trust regime.  However, using a CCIV, the fund is likely to be taxed as a company. This would remove the tax concessions application to depreciation, discount capital gains, foreign income tax offsets and misalignment with corporate tax rates (i.e. 27.5% versus 30%).  Accordingly, for these smaller wholesale funds, a unit trust arrangement would seem to be the better option.

Could a CCIV be used for “active” funds?

While managed investment schemes are intended to be used for “passive” activities, the provisions currently only have a small number of limitations that would need to be managed if “active” arrangements are to be placed into a CCIV (e.g. a property development fund).

For example, a CCIV cannot have employees (which the explanatory material states is intended to ensure that the CCIV is passive).  Furthermore, a CCIV will be required to carry on passive activities (i.e. to satisfy the Division 6C of the income tax provisions, being the public trading trust provisions) in order to be treated as a flow-through vehicle. 

However, the current explanatory material is not entirely clear on the proposed taxation treatment of a CCIV if it carries on trading activities using sub-contractors (e.g. the engagement of a developer or manager).  One would guess that the CCIV would be treated as a company for income tax purposes, but it is unclear whether each sub-fund would be treated as a separate entity, or if the CCIV would be treated as a single company and taxed accordingly.

For those that utilise wholesale MIS arrangements for collective investment in property development activities, it will be important to understand the final position of the Treasury on these issues to determine whether the new CCIV regime could potentially be a better alternative to a MIS.

Where to next?

Pitcher Partners has been attending the workshops with Treasury, ASIC and the ATO and will be lodging a submission on the CCIV regime exposure draft.  We expect the tax provisions to be released shortly. 

While the Government originally announced that the application date would be from 1 July 2017, we believe that there is still a while to go to get the regime in an appropriate format (including the release of consequential amendments).  Accordingly, there is a risk that the regime may not even be ready from 1 July 2018 (even though this would be the planned date). 

In the meantime, the Treasury are also working on a limited partnership collective investment model, which is also due to be released soon.

If you are interested in discussing any of the contents of this bulletin, please contact Pitcher Partners and we would be happy to talk to you about the CCIV regime may apply to you.


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