Australian Tax Office Attacks Inbound Investment Structure
Media Release - 20 November 2009
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| Location: | Sydney |
| Division: | Tax Consulting |
| Publish Date: | 2/12/2009 |
In an unexpected move, the Australian Taxation Office ("ATO") has raised an income tax assessment plus a substantial penalty on the Australian profits earned by a non-resident private equity fund. Although in this instance a private equity fund is involved, the move potentially has far wider implications for non-resident investors into Australia.
Investment Structure
Texas Pacific Group, a US based private equity fund, had taken an investment position in the Australian company which owned Myer, one of Australia's leading retail department store chains. TPG structured its investment through a Cayman Islands company (TPG Newbridge Myer) which owned a Luxembourg company (NB Queen) which in turn owned a Netherlands company (NB Swanston). The Netherlands holding company owned the investment in Myer Holdings.
This type of structure is common for non-resident equity funds investing into Australia.
Australia-Netherlands Double Tax Agreement
Australia and the Netherlands entered into a double tax agreement in 1976 which was most recently updated in 1986. This treaty does not specifically deal with capital gains, the taxation of which was introduced in Australia only in 1985.
But based on recent Australian court decisions, capital gains made by Netherlands' residents on realization of Australian based assets, other than direct and indirect interests in Australian real estate, would be the subject of the treaty and would not subject to Australian income tax provided that the Netherlands' residents do not have permanent establishments in Australia.
Therefore, on the sale of the Netherlands company's investment in Myer Holdings it was expected that any profit on sale would not be subject to Australian income tax.
Australia does not have double tax agreements with either Luxembourg or the Cayman Islands.
Public Listing
Earlier this month ( November, 2009) Myer Holdings was publicly listed on the Australian Stock Exchange, raising A$2.4 billion for its former shareholders including TPG. TPG's profit on the float was A$1.5 billion.
Income Tax Assessment
The ATO issued an income tax assessment to the Netherlands company for A$452 million income tax and a penalty of A$226 million. It also sought Court orders to freeze bank accounts containing some of the proceeds on the public float in an effort to secure payment of the income tax assessment.
The assessment has apparently been issued under the general anti-tax avoidance provision of Australia's tax laws. Under this provision, the ATO can set aside or ignore arrangements where one of the participants has a dominant purpose of tax avoidance, and impose substantial penalties.
The basis of the ATO's income tax assessment appears to be, first, that a purpose of the investment structure, and in particular the inclusion of the Netherlands holding company, was tax avoidance. This would explain why the income tax assessment has been issued under the general anti-tax avoidance provision.
Secondly, the ATO appear to have taken the view that if the profit had been earned directly by TPG, rather than by the Netherlands holding company, it would have been ordinary trading income rather than a capital gain. This view would be based on the presumption that from the outset it was TPG's intention to sell its investment in Myer Holdings for a profit.
Policy Issue
Australia's Government policy has been to encourage foreign investment and the flow of capital funds into Australia. Accordingly, in 2006 Australia's tax laws were amended to provide that non-resident investors into Australia would not be subject to Australian income tax on capital gains made on realization of Australian based assets, other than direct and indirect interests in Australian real estate.
Although the ATO's move is contrary to Australian Government policy, it would no doubt be defended by the ATO as being the proper administration of the tax law.
Wider Implications
The ATO's move has wider implications for other investors into Australia which have structured their investments to take advantage of Australia's DTA's providing relief from Australian capital gains tax. If the ATO take the view that such investors have ‘treaty shopped' and also that their intention is to sell their Australian investments for a profit, the ATO could issue the same sort of income tax assessments to them when they sell their Australian investments.
It is also possible that the ATO may take the view that Australian based private equity funds make their investments with the intention of selling them at a profit. In this case, the ATO would argue that the funds are in the business of making and selling their investments and are not entitled to the Australian income tax concessions applicable to capital gains on assets held for at least twelve months.