Submission No. 244 Back to full list of submissions
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The Secretary
Review of Business Taxation
Department of the Treasury
Parkes Place

Email :


16 April, 1999


Reference: BPL


Dear Sir

Subject: Taxation of Investment in Real Estate

This submission is made to draw attention to the adverse impact on

  • investment in real estate
  • existing entities and structure used to hold real estate investments
  • the return on savings, including superannuation savings, that have been directed to real estate investment

from some of the options contained in the Review of Business Taxation, a platform for consultation, Discussion Paper 2 of the Ralph Committee.

Executive Summary


This letter contains three submissions.

Depreciation on plant and equipment and capital allowances for building and structures should not be reduced.

Collective investment vehicles (CIV’s) as flow through entities must extend to property trusts and to wholesale investment vehicles.

CIV’s should have full flow through for tax purposes, including flow through of tax preferred amounts.

Supporting Arguments


  • international comparisons do not show a clear need to reduce Australian depreciation
  • economic life of assets must be taken into account, rather than simply effective life
  • buildings do depreciate in value, or do require on going capital expenditure to retain their value. The current 2.5% or 4% capital allowances are appropriate recognition of this.
  • tax deductions similar to those under the current system should continue

Definition of CIV

  • a widely held definition is appropriate but it must cover wholesale CIV’s and adopting the wholesale widely held trust definition from the existing trust loss rules may be appropriate
  • a passive portfolio investment definition must extend to real estate investments as generally understood
  • the definition must be wide enough to cater for practical situations where non rent income is also derived e.g. car park revenue, etc

Full Flow Through of Tax Preferred Amounts

  • a full flow through of annual profits is appropriate
  • rather than 100% requirement each year, say, 95% requirement would allow for practical flexibility
  • the current 100% distribution requirement for unit trusts has some uncertainties and technical deficiencies which should be rectified
  • not allowing full flow through of tax character, including tax preferred amounts would adversely affect competitive neutrality
  • the appropriate comparison is a direct investment in real estate by the ultimate investor
  • as well as the US taxation model for mutual funds the US taxation model For Real Estate Investments Trusts (REIT) should be considered


(1) We submit there is no persuasive reason to reduce the availability of depreciation on plant and equipment nor the availability of capital allowances for investment in buildings.

(2) We strongly support the concept of collective investment vehicles (CIV’s) as flow through entities. However, we believe the definition of CIV’s needs to cater for those genuine investment vehicles currently existing including property trusts in general, wholesale property trusts etc.

(3) On the basis that CIV’s are adopted as flow through entities under a new tax regime, we believe the flow through should act to put the ultimate investor in the same position as if they had invested directly in the underlying investment themselves, ie the CIV should be a complete flow through. This should apply to all aspects including the flow through of tax preferred amounts.


We note that the statement at paragraph 2.21 of Discussion Paper 2 that "An International Perspective concluded that Australia provides accelerated depreciation for short life assets more or less in line with the average for the countries considered. However, Australia’s depreciation tends to be more favourable for assets with lives beyond about 8 to 10 years."

This seems to indicate that there is no clearly defined need, on the basis of international competitiveness, to reduce the tax deductions available from depreciation.

We note the reform options for depreciation considered at paragraphs 2.28 and 2.29 fail to consider economic life as an alternative period for depreciation. Rather the period referred to is always effective life. The objectives of taxation reform are stated (at paragraph 8 on page 6) as being to achieve better economic performance, stimulate investment and innovation, and achieve a better functioning capital market. The Review is also asked to explore bringing tax value and commercial value closer together. This all seems to point to economic life as a correct measure. We note that economic life is usually far shorter than effective life due to technological advances, or the need to upgrade to modern and better equipment, even though old equipment may still have effective life, it no longer has economic life.

In relation to buildings in particular, the availability of deductions at 2.5% or 4% has been attacked as being too generous. Firstly, it is important to separate expenditure on buildings from expenditure on land. It is usually the value of the land that increases. Buildings by their very nature require on going expenditure only some of which (maintenance and repairs) is tax deductible, while other expenditure (improvements, extensions and replacements of the whole) receive no tax preference other than the 2.5% or 4% allowance. Many buildings do in fact have an economic and effective life less than 40 years (reflecting the 2.5% rate).

We strongly support the continuation of some form of tax depreciation regime with rates similar to those presently available. We also strongly support a regime which provides for tax deductions on the cost of buildings at rates similar to those presently available.

Collective Investment Vehicles – Definition must be wide enough

We support the creation of a category of entity as a collective investment vehicle, to be a flow through taxation entity.

Vehicles currently constituted as unit trusts reflect the type of vehicle we believe should be classified as a CIV.

However, we see no reason to limit the type of entity to unit trusts. Consistent with the remainder of A New Tax System, the CIV definition could equally apply to companies.

We note the proposed definition of CIV’s to include :

  • widely held
  • full flow through of annual profits
  • passive portfolio investment and not active business operations

Widely Held

The widely held aspect of the definition is appropriate. However, we submit this must include tracing provisions to allow "wholesale CIV’s" to be included. For example, the definition could be that of wholesale widely held trusts from the existing trust loss rules at section 272-125. Broadly this would include a trust (or entity) as a CIV if at least 75% of the units are held by one or more :

  • listed CIV
  • another wholesale CIV
  • complying superannuation fund or similar entity

Full Flow Through of Annual Profits

We note and agree with the requirement for a full flow through of annual profits. This will be similar to the present situation for unit trusts.

We would request that the 100% requirement should be reduced to, say, 95%. This would allow some flexibility in, for example, dealing with uncertainties at year end when distributions have to be determined. Shortfalls could be carried forward to following years distributions.

In addition, we note some uncertainties currently existing in the 100% distribution requirement for unit trusts. These arise from technical problems and deficiencies in the law which generates confusion, for example, whether a trust must distribute 100% of its accounting income, 100% of its taxable income or 100% of its income as defined under its trust deed. Any revised system should provide clarity.

3) Passive Portfolio Investments

We note the suggestion at paragraph 16.24 that acquiring a controlling or non portfolio interest in part of the asset base of an active business – such as office buildings or shopping centres is canvassed as itself being an active business and hence disqualified from CIV status.

We strongly oppose the suggestion. All investment in real estate which generates its principal income from rental streams should qualify for CIV status.

Managing any real estate, to a greater or lesser degree, requires some active management of the asset. However, real estate is one of the major asset categories for investment and should not be treated differently to the other categories such as interest bearing securities or shares. In addition, artificial restraint which could cause less than optimal management of real estate investments should not be imposed.

Particular activities which should be taken into account and included in the definition of passive portfolio investment for real estate investments would include:

  • the operation of car parks located under or directly adjacent to buildings which are owned for rental purposes. Car park revenue may not strictly be in the form of rent
  • the need for shopping centres to provide promotional activities to encourage shoppers to visit the centres
  • the on-selling to tenants in buildings services related to their tenancy, eg cleaning, electricity, etc

Flow Through of Tax Preferred Amounts

In relation to CIV’s we strongly endorse the flow through principles.

We believe the 3 principles outlined at paragraph 34 of page 13 should be fully applied in relation to CIV’s. These 3 principles are

  • entities should be considered as extensions of the ultimate owners
  • income should not bear more than a single layer of Australian tax
  • tax arrangements should avoid differentially taxing either the type of entity or the type of income distribution from entities

In simple terms, these principles would be fully addressed by having totality of flow through of CIV’s. That is, flow through of type of income, character of income, source of income etc.

Clause 16.18 Discussion Paper 2 states that "… flow through tax treatment poses the further question as to whether tax preferred income distributed from CIV’s should be taxed in members’ hands." However, we do not understand why this question is posed.

To seek to impose taxation at the investor level on tax preferred income would simply create a distortion in the investment regime, would interfere with competitive neutrality and potentially would reduce after tax returns for savings invested in real property via CIV’s.


A simple example demonstrates the point. A large superannuation fund with $200 million to invest in a property asset class could either invest its funds directly in real estate or indirectly by holding securities in CIV’s that themselves hold real estate. The decision for the superannuation fund would normally be driven by two main factors, firstly the availability of real estate investment expertise, and secondly the desire to mitigate investment risks by putting its funds into a larger investment pool. A third factor may also be influential, being the increased liquidity of securitised property investments versus direct property. If the CIV’s regime did not allow full flow through of tax preferred amounts, an additional tax factor would enter the decision making process of the above superannuation fund, i.e. there would not be competitive neutrality between the fund investing directly in property (which would give a benefit of tax preferred amounts) against the CIV real property investment (which would lose the tax preferred benefits). The overall result could be that the tax influence would generate a sub optimal decision from an economic and capital market standpoint.

We note that the option of not taxing tax preferred income is considered at paragraphs 16.19 to 16.27 of the Discussion Paper 2.

At paragraph 16.20 it is noted that not taxing tax preferred income would have revenue costs. There would be no revenue costs as compared to the current position. Currently tax preferred amounts do flow through unit trusts.

We also note the comments on competitive neutrality at paragraphs 16.23 to 16.25. We do not believe that allowing tax preferred amounts to flow through would adversely affect competitive neutrality. CIV’s owning real estate do not compete with entities carrying on active businesses. The ownership of real estate is essentially a passive investment form even though certain peripheral active actions may occur. Rather, as noted above, we propose that allowing tax preferred flow through would enhance competitive neutrality with the alternative of direct real estate investments.

Comparisons are made in the Discussion Paper with the rules governing the taxation of US mutual funds. The conclusion is drawn that US rules suggest a requirement, if tax preferences are preserved, that CIV’s undertake portfolio investments in shares of other entities or invest in fixed interest securities only. However, we also draw your attention to the Real Estate Investment Trust (REIT) rules governing the taxation of real estate owning collective investment vehicles in the US.

Impact on CFM Property Fund

The organisation we represent is the CFM Property Fund. This is a unit trust wholly owned by a small number of complying superannuation funds. The fund has a value of approximately $1800 million invested in 9 properties. The fund has been in existence for in excess of 10 years. The fund is substantially held, 68% by the Commonwealth Superannuation Scheme No 2 and the Commonwealth Superannuation Scheme No 1 (the "CSS/PSS") the superannuation funds for federal public servants. The financial returns from the CFM Property Fund will in part determine the investment returns of the CSS/PSS.

Because all the investors in CFM Property Fund are complying superannuation funds paying tax at concessional rates, it would be significantly disadvantageous for the fund if it would not qualify as a CIV but be taxed in its own right. Given that the fund is in fact really a collection of investment monies, not qualifying as a CIV would appear inconsistent. From this aspect it can be seen extending the definition of CIV’s to cover wholesale type funds like the CFM Property Fund is vital to the ongoing viability of the CFM Property Fund.

Should tax preferred amounts not be permitted to retain their character when distributed by CIV’s, the investors in the CFM Property Fund will be suffering an economic detriment, compared to them undertaking similar direct real estate investment themselves. Should the flow through of tax preferred amounts be denied, viability of a pooled real estate investment in the form of CFM Property Fund would be called into question. The investors could determine that it would be economically more advantageous for them to hold the real estate investments directly in their own names, or possibly as tenants-in-common. That is, the tax ingredients could generate a sub optimal economic decision going right to the viability of the CFM Property Fund.

We also note that the transitional arrangements for entities that are currently flow through entities (unit trusts like the CFM Property Fund) need to be carefully considered. This applies whether our submissions above are accepted, but probably more so if one or more of our submissions are not accepted. Significant and unwarranted adverse tax implications could arise should either the CFM Property Fund fail to meet the new definition of a CIV, or should tax preferred amounts not be permitted to pass through to the ultimate investors. This could arise, for example, where realised or unrealised capital losses currently exist within a fund. Under the present rules, such losses could shelter future gains, which would then be passed out as tax deferred distributions to investors. This could be prevented under some of the Discussion Paper 2 options.

Contact Details

Should you wish to discuss any of the matters raised in this submission, please contact Joanna Wakefield, Trust Finance Executive, Commonwealth Property, Commonwealth Bank of Australia on 02-9378 4542, or Brian Lawrence on 02-8266 5221.

Yours faithfully


Brian Lawrence