Navigating year-end tax planning for managed funds: Top tips

As we near the end of the financial year, responsible entities, trustees and fund managers must prioritise tax compliance and investor reporting. Failing to address key issues could lead to unexpected tax liabilities for trustees or significant taxable income for members without sufficient cash distributions.

1. Setting a timetable 

Where your fund has made distributions during the income year, arrange a time with your tax advisors to review and complete the investor tax (or AMMA) statements before issuing them. Fund tax advisers and administrators acting for multiple fund managers will typically lock in their resources based on agreed upon year-end timetable.

Tip: The earlier the timetable is set, the greater certainty there will be around meeting investor expectations on delivering the investor statements on a timely basis. We strongly recommend that you get in touch with your tax advisor, fund administrator and custodian (if applicable) to find out when the investor tax (or AMMA) statements will be issued to your investors. This will help you to set a suitable timetable.

2. Final Distributions 

If you are proposing to make a final distribution for the income year, you should review the trust deed to consider, amongst other things, the income of the trust estate (“distributable income”) and net (taxable) income for tax purposes. If these items are not appropriately managed, there is a risk that the trustee may be subject to tax at the top marginal rate. It is prudent for trustees to document and minute their resolutions.

Tip: Where the fund is not an attribution MIT (“AMIT”), you should ensure that resolutions are in place by 30 June (or that you are comfortable with the way in which the trust deed automatically distributes amounts to the beneficiaries). Where the fund is an AMIT, the trust deed may have automatic distribution clauses that can create legal distributions to investors at 30 June (that may be indefeasible). Accordingly, it is always prudent to review the trust deed and consider alternative determinations where the automatic distribution clauses are not appropriate.

3. Consider the continued status of the fund as MIT or AMIT 

A fund that qualifies as a MIT gains access to several advantages, including concessional withholding rates for foreign investors, the ability to make a capital account election (which allows the Fund to treat certain property disposals on capital account), and the choice to treat the fund as an AMIT. Funds looking to operate as MITs must make the election in the first year in which it becomes a MIT. Where the election is not made by the required time, the fund will not have the ability to do so later.

Tip: If the Fund operates as a MIT, consider your Fund’s ability to satisfy the MIT requirements for the current year. Particular caution should be given during the start-up period; newly established funds have up to two income years to meet MIT membership requirements, meaning funds may be deemed to be MITs earlier than expected leaving the Fund out of time to make an election. Additionally, funds that relied on the start-up period to make the AMIT election must ensure they continue to meet the requirements so that they do not fall out of the regime. If you do not accurately determine whether the Fund is a MIT or AMIT, you are at risk of providing the wrong reports to your investors and the ATO (i.e. AIIR and tax distribution statements).

4. Satisfying the Public Trading Trust Provisions 

A Fund that is a public unit trust can be taxed as a company where it carries on ‘trading’ activities. Even where a unit trust is not a public unit trust, the carrying on of trading activities may result in the Fund ceasing to be a MIT and no longer qualifying for the capital account election or AMIT status.

Tip: It is critical the Fund’s compliance with these provisions is reviewed on an annual basis, particularly where the fund has acquired new investments during the income year, to determine whether a breach of the provisions may occur and what preventative measures (if any) you should be considering before 30 June.

5. Significant transactions 

Significant transactions can have substantial effects on a fund’s bottom line. Even where transactions do not give rise to reductions in taxable income, a loss for accounting purposes could possibly impact investor reporting.

Tip: Consider the impact of any material or once off transactions during the year and seek advice as to the accounting and taxation treatment for the transaction. Transactions could include: property or other asset disposals, looking to freeze distributions, putting loan repayments or interest income on hold, writing off bad or doubtful debts, or dealing with provisions for impairments of value.

6. Preserving losses 

Managed funds are subject to the trust tax loss provisions that (generally) do not provide the fund with a ‘same’ or ‘similar’ business test. Instead, the fund must satisfy a ‘continuity of ownership’ test that generally requires the trust be both a fixed trust and that it can trace through to the same persons holding the units during the relevant period. These rules are complex and the process of tracing through investor vehicles can be lengthy, depending on the nature of the information available. Where the Fund cannot evidence a continuity of the same persons, the use of tax losses can be denied.

Tip: If your fund is expecting to utilise prior year tax losses in the current income year, it is critically important that you consider your funds eligibility to use those losses. We strongly recommend that you or your tax advisor should consider this issue having regard to your fund as soon as possible.

7. Bad debt write-offs

If the fund has a bad or doubtful debts, specific rules apply to determine whether a deduction is available in respect of the unrecovered amount. Crucially, much like the use of tax loses, only those debts for which the fund satisfies a continuity of ownership test will meet these requirements. Failure to substantiate that the majority of the same persons held units in the Fund during the relevant period will mean that no amount can be deducted to reduce the accrued income.

Tip: Ensure you have considered the continuity of ownership tests at the necessary times before deducting any amounts for unrecovered amounts. The provisions provide a deduction for income amounts (e.g. interest and rent) as well as the principal of the loan where the Fund is a money lender. Each of these items have different continuity of ownership periods where the debt is written off. Additionally, the debt needs to be ‘written off’ prior to 30 June. This means that the debt needs to be appropriately authorised as being written off in the books (authorised journal entries) by 30 June or supported by a minute or director’s resolution that is similarly authorised by that date.

8. Non-accrual loans

Where you operate a debt fund and the fund currently holds loans that either have a high chance of or are currently in default, there may be an ability to ‘turn off’ accruing the interest income during the year from an income tax perspective. The ability to do so will depend on whether certain criteria are satisfied (as set out in the Taxation of Financial Arrangements (“TOFA”) rules where your fund is subject to that regime, or whether your fund would meet the criteria non-accrual loan requirements outlined in Taxation Ruling TR 94/32).

Tip: This is an important part of year-end planning, as non-accrual loans (loans where the interest income does not accrue) do not require complex continuity of ownership testing and may help to minimise the differences between tax and accounting amounts.

9. Consider the impact of the New thin cap rules

The new thin capitalisation rules apply from 1 July 2023. Funds that are foreign controlled, or majority foreign owned or have foreign investments may be subject to new rules that limit annual net debt deductions to 30% of its tax EBITDA (carried forward for up to 15 years). Distributions from entities in which a 10% interest is held are excluded from tax EBITDA which may have a significant impact on funds borrowed to hold equity investments. Funds that only used third party borrowings may be able to elect to apply the third-party debt test to preserve their interest deductions.

Tip: The new rules are a fundamental change to the earlier balance sheet safe harbour. Funds that may have been able to deduct all their interest in prior years may now find they have material denials under the new earnings-based test. It is imperative that you consider the application of the new rules, including whether the alternative third-party debt test can be elected into that allows entities to claim all debt deductions in respect of certain third party debt. While a Fund may only have third-party borrowings, the restrictive drafting of the provisions may deny the use of the third-party debt test in many circumstances. Accordingly, it will be crucial to examine the legal agreements involving both the borrower and any ‘obligor’ in respect of the borrowings (including entities that have provided credit support).

10. Consider the impact of the new debt deductions creation rules 

From 1 July 2024, Funds may also be subject to the new debt deduction creation rules (“DDCR”). These rules can apply to entities that are subject to thin capitalisation as well as those entities excluded from the thin capitalisation provisions due to the 90% Australian asset test. The provisions are drafted such that they can apply to historical transactions (no matter how far they date back) that still exist at 1 July 2024. For example, where associate debt has been used to fund a distribution of income or capital to investors, the interest expense on such debt can be wholly non-deductible under the DDCR.

Tip: The DDCR is expected to have a material impact on associate entity debt provided to the Fund and can result in material non-deductible amounts. There are also anti-avoidance provisions that can apply where debt funding is restructured. Trustees and managers should be critically considering the potential application of these rules as soon as possible.

11. Don’t miss key upcoming tax compliance dates 

The timely reporting of trust information to members is crucial to enable those investors to complete their own income tax returns. Various reports are required to be submitted to the ATO disclosing the trust income as well as reporting on the allocation of income to its members that feeds into its data matching program.

Tip: Be aware of the deadlines that apply to your fund. Significant penalties can apply to funds that do not meet these obligations.

What are the next steps?

There are many other year end planning items that must be considered by a fund. Clients should contact their Pitcher Partners representative to organise a year-end tax planning catchup, so that you can review your situation and determine what action is required well before 30 June.