ATO approach invites treaty 'shopping'
ATO approach invites treaty 'shopping'
15 Jun 2010
A version of this opinion was first published in the Australian Financial Review on 6 June 2010
Foreign blue chip companies and private equity firms wanted to invest in Australia because it offers them lucrative tax breaks. In 2006 foreign investors were allowed tax free status on capital gains. Texas Pacific Group (TPG) and other private equity firms took note only to find out three years later that the ATO was going to tax windfall profits as ordinary income, thus denying them the benefit of their capital gains tax free status.
TPG bought Myer in 2006 with a private equity firm Blum Capital. The Myer family had sold its shares in Myer in 2009 as part of the float. TPG and Blum received almost $1.6 billion from the float and the ATO sought a Victorian Supreme Court injunction against two TPG companies preventing the firm from dealing with bank accounts that supposedly held the proceeds. The ATO assessed Queen SARL of Luxemburg and TPG Newbridge Myer in the Cayman Islands.
The ATO argued: “From the commissioner’s experience when dealing with structures such as these, one of the effects of that structure is that once funds are remitted offshore, then there is nothing in Australia which can be used to satisfy a judgment debt.”
The Supreme Court dismissed the action after it became clear the bank accounts had been emptied out and the proceeds sent to an offshore tax haven where the ATO had neither a Double Tax Agreement (“DTA”) nor a Tax Information Exchange Agreement. This meant the ATO would be unable to enforce any judgment in its favour. TPG used a tax treaty and argued their active business income was passive investment income and they had no permanent presence in Australia.
The ATO subsequently issued two draft rulings explaining how it was going to treat private equity firms under the rulings. The Commissioner was due to release its final rulings on 26 May 2010, but deferred them yet again and has set no concrete date for its final rulings.
The draft rulings deal with the distinction between capital and income and the way the ATO wants to apply its anti-general avoidance provisions to treaty shopping and capital reduction schemes. Another key concern is to what extent the ATO will draw the line between “treaty shopping” and legitimate “tax competition”?
Some critics argue that treaty shopping is a form of tax avoidance while tax competition is a way of finding the best available legal structures and tax rates. Private equity firms legitimately shop around for competitive tax rates, finance and treaty benefits. These arrangements should not fall under the hammer of the Commissioner’s anti-treaty shopping or general anti-avoidance provisions.
Of more concern to private equity investors, there has not been full transparency from the ATO over the CGT amendments. As the law stands, private equity investors are not clear what policy changes will take place in the future with respect to the tax free status on foreign CGT. The ATO has taken a firm stance on taxation of private equity investors and the use of general anti-avoidance provisions. It is unlikely the Commissioner will change his views in the final rulings. He will likely want to tax private equity investors on windfall profits as ordinary assessable income rather than as tax free capital gains.
The Commissioner will also look very closely at private equity firms that use leveraged capital reduction schemes, or schemes of treaty shopping using offshore companies and trusts to avoid paying taxes in Australia so as to return capital back to investors tax free. As part of the package, the way private equity firms have dealt with the Foreign Investment Review Board will also be examined.
Private equity firms considering offers for Australian companies are holding off for the Commissioner’s final rulings. In my view, the Commissioner would not want another TPG/Myer. Private equity firms and or private investors should now be aware that the ATO will be monitoring all deals . The ATO will be lining up its “ducks” ready to strike.
If the ATO is going to shift the goal posts and deny foreign investors tax free status on capital gains, it should dump the exemption altogether and tax the gains as ‘windfall profits” as ordinary assessable income.
The danger with this approach is that it will promote tax avoidance using treaty shopping and capital reduction schemes, and encourage private equity firms to shift their global headquarters to specific countries that have bilateral tax treaties in place with Australia. This would also allow private equity firms and investors full treaty protection; and allow them to pay tax on income in that jurisdiction as opposed to Australia. This would totally undermine what the policy and legislation was set to achieve in the first place and makes no sense. This will only damage Australia’s foreign investment and tax policies in future.
As a result, private equity firms will be forced to look at transferring their financial and tax affairs and domiciles into more favourable tax jurisdictions utilizing Australia’s international tax treaty network. This would make permanent establishments in Australia irrelevant, as Australia cannot tax the profits of foreign private equity firms and their investors unless they carry on business through a permanent establishment in Australia.
As shown by the private equity battle over Healthscope and more recently by HSBC’s sale of its business units to private equity investors, some private equity deals will go ahead in spite of the uncertainty and added risk. However, foreign private equity firms’ eagerness to bid in the Australian market should not be taken for granted.