Upcoming Mallesons seminarsAll foreign investors, particularly those who use an offshore holding company.
What do you need to do?Review the draft rulings to determine if they affect you and make a submission where necessary.
Richard Snowden
Partner
Scott Heezen
Senior Associate
Richard Snowden
Partner
T +61 2 9296 2193
Phillip Davies
Partner
T +61 3 9643 4106
Sydney
John King
The Commissioner of Taxation today released two important draft determinations (rulings) dealing with the taxation of foreign private equity entities (TD 2009/D18) and the application of Part IVA (the general anti-avoidance provision) to treaty shopping structures (TD 2009/D17).
The draft rulings follow the recent case involving a foreign private equity firm (TPG) where the Commissioner has asserted that the proceeds of sale from the Myer float were taxable in Australia notwithstanding that the sale was undertaken by a Netherlands holding company that ordinarily would be able to claim treaty protection.
The major points arising from the rulings may be summarised as follows:
Foreign private equity
Where a foreign private equity firm that is not in a treaty country carries on a business of deriving a profit from the sale of an Australian asset then the profit is ordinary income which is taxable in Australia and is not exempt as a capital gain.
The example noted in the draft ruling is where a private equity firm acquires an Australian asset with the intention of restructuring its activities and re-floating the company on an Australian Stock Exchange. As the firm does not have the intention of becoming a long term investor to derive dividend income from its shares and is carrying on a business of restructuring and floating companies, due to the regularity, repetition, size and scale of its activities, the profit from the disposal of shares in the Australian public company would constitute ordinary income.
The ruling notes that ordinary income treatment may arise even where the profit is from an isolated transaction carried on for that purpose and not part of a continuing business of buying and restructuring, provided there are significant commercial aspects to the sale.
While the draft ruling is specific to private equity where arguably there is a clearer intent to acquire and sell at a commercial profit it has wider implications for foreign investors who are merely trading in Australian securities. It also leaves open the issue of a private equity firm that may acquire the asset for a longer term holding as a portfolio investment without the ability or influence to restructure the company.
Finally the ruling does not address the source rules which are an essential element of taxation to a foreign investor. For example if the sale takes place between two non-residents as a contractual matter, then depending on the circumstances the source may be regarded as outside Australia and therefore not taxable.
Treaty shopping
The second draft ruling considers the application of Australia’s general anti-avoidance provision, Part IVA, to “treaty shopping” arrangements. Treaty shopping is the practice of interposing an entity between two countries, to benefit from the terms of a particular double tax treaty. It is noted that the Commissioner has asserted Part IVA in the recent TPG case.
Under Australia’s tax laws, the application and scope of Australia’s tax treaties is subject to the operation of Part IVA. Part IVA is the general tax anti-avoidance provision which can apply to schemes put in place with the purpose of reducing Australian income tax. The draft ruling makes it clear that the ATO will consider applying Part IVA to offshore ownership structures for Australian assets where such arrangements are put in place “merely to attract the operation of a particular tax treaty”.
In particular, although the ATO acknowledges that any application of Part IVA requires consideration of the particular facts of each case, the view expressed in the draft ruling is that:
“in the absence of any significant commercial activity in a treaty country by a resident in that jurisdiction, the presence of a company in that jurisdiction in the context of a cross-border structure is normally to be explained by taxation considerations… If there are relatively few, or no advantages to be obtained from the presence of a company in the relevant jurisdiction other than the exemption from Australian tax, this will point to the conclusion that obtaining a tax benefit is the dominant purpose of one or more participants in the scheme.”
Although a number of Australia’s more recently negotiated double tax treaties have specific treaty shopping provisions (often known as “limitation on benefits” provisions), Australia’s treaty with the Netherlands does not have such a provision. Accordingly, the ATO will be required to apply Part IVA to deny the benefit of such treaties in those cases.
The draft ruling appears to set the threshold at which the ATO will consider the potential application of Part IVA to an offshore structure at a relatively low level. By requiring clear commercial rationale for the establishment of an entity in a particular tax treaty jurisdiction (apart from the mitigation of Australian tax) the ATO is seeking to place the evidentiary onus on non-residents to support their choice of business structure.
The draft ruling is yet another indication of the seriousness with which the ATO is taking international tax structuring arrangements and the perceived avoidance of Australian tax by non-resident investors. It places persons that invest into Australia through interposed entities on notice that unless there is some clear commercial rationale or substance to the interposed entities, the ATO will consider applying Part IVA to the arrangement if the use of such structures gives rise to an Australian tax benefit.
The draft determination does not, however, address the complications faced by the ATO in seeking to enforce the application of Part IVA to such arrangements, as was clearly evidenced with TPG whereby the funds had left Australia before action was taken by the ATO.
The adoption by the ATO of a Part IVA approach appears to ignore to some extent the collective vehicle aspect of the structure and that ultimately many of the underlying investors are themselves in treaty countries. For instance a US investor might invest via a Cayman Island Fund which in turn uses a Netherlands holding company. In such a case if the US investor invested directly there would be little doubt that treaty benefits would be available. In this regard, recent draft recommendations of the OECD Committee on Fiscal Affairs in relation to the availability of treaty benefits for members of collective investment vehicles supports a “look through approach” as do the more recent amendments to treaties such as Australia’s treaty with New Zealand.
Submissions need to be made by 29 January 2010.