ATOs stance on private equity profits still a sticking point: Bartholomeusz

It has taken the Australian Taxation Office 12 months to come to the same conclusion about the structure TPG used to shift the $1.5 billion of profits it made from floating Myer to the Cayman Islands as it did a year ago. In the meantime, the private equity caravan has moved on.

The ATO issued a final determination on tax treaty shopping today in which it came to the conclusion that the anti-avoidance catch-all section of the Tax Act, Part IVA, can apply to arrangements “designed to alter the intended effect of Australia’s international tax agreements network.”

The example it provided of the kind of arrangement it was referring to was the same as the one it used last year – and the same structure TPG used to acquire Myer and then repatriate the proceeds of the float almost as soon as it received them. The structure has been commonly and frequently used by international pooled funds managers.

A Dutch holding company owns a newly-incorporated Australian company that acquires all of the shares in “Target Co”, which the ATO describes as a manufacturing company (but which could equally be a retailer). The Dutch company is itself owed by a Luxembourg entity that in turn is owned by an entity resident in the Cayman Islands.

There is, the ATO says, no commercial reason for using Dutch and Luxembourg entities as intermediaries but there is a tax benefit in having the profit on the sale of the Australian flow first to a Dutch entity rather than directly to the Caymans because Australia has a tax treaty with the Netherlands.

Australia doesn’t tax the profits of residents of countries with which it has a tax treaty. It doesn’t have one with the Caymans and therefore, had the European entities not be interposed, the profit would have been taxable before it left the shores.

Private equity groups have never argued that the widespread use of similar structures (the Future Fund uses the Caymans as a conduit for its international investing) is about anything other than tax. They would argue, however, that it is about tax efficiency rather than tax avoidance – it is about being able to pool funds from international investors without unnecessary tax leakage.

The investors are primarily institutional or high net worth individuals and the private equity funds invest around the globe. Almost overwhelmingly they would be resident in countries with which Australia does have a tax treaty.

While acknowledging that the use of a Cayman Islands entity may be largely or even solely due to US tax considerations, the ATO’s effective view of the structure as one that ends in the Caymans is unchanged.

The recently acquisition of Healthscope by TPG and Carlyle, the approach by KKR to Perpetual and that of another US private equity group to Foster’s suggests that foreign private equity is still interested in Australia. Presumably they are using different structures to that used by TPG for Myer, or perhaps are factoring in some domestic tax into their numbers.

They are getting on with business but the Australian Private Equity and Venture Capital Association hasn’t given up on the issue, saying that the issuance of the determination clears the way for it to engage with the federal government to provide certainty on tax issues for foreign investors.

While the current climate in Canberra may not be particularly receptive to a plea for a more generous treatment of foreign investors in private equity or infrastructure, the basic policy philosophy that underpins the tax treaties Australia has entered into – that the tax on capital gains is the business of those countries where the actual investors are resident – would appear to be undermined by the ATO’s stance.

This article first appeared on Business Spectator.