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Australian Govt Looking Closely At ATO's Private Equity Tax Rulings

Tuesday, February 23, 2010

During a speech to a tax forum in Melbourne, Australia’s Assistant Treasurer, Nick Sherry, disclosed that the government is looking closely at the two draft determinations made by the Australian Taxation Office (ATO), on the tax treatment of private equity investments by foreign investors.

The ATO’s tax determinations in December last year regarded the two main questions behind its AUD678m (USD610m) claim for tax and penalties following the sale of the Myer department store group by a private equity group using tiers of foreign ownership. They have raised doubts in the minds of offshore investors about the suitability of undertaking business in the Australian capital markets.

In the first draft determination, the ATO considered that a private equity entity can make an income gain subject to company tax from the disposal of the target assets it has acquired. If the entity does not have the intention of becoming a long-term investor to derive dividend income from its shares, and if it is carrying on a business of restructuring and floating companies, due to the regularity and repetition and size and scale of its activities, the profit from the disposal of shares in the Australian public company would constitute ordinary income.

That draft determination reiterates that, where the private equity entity that has acquired Australian target assets is a resident of a country with whom Australia has a tax treaty, the business profits article in the relevant treaty will determine which country has the taxing rights in respect of that profit.

However, the ATO’s second determination then goes on to say that, if the above-mentioned profit made by a private equity group is considered as taxable income, any arrangements in making that profit which are designed with the sole purpose of altering the intended effect of Australia's international tax agreements network, or using so-called “treaty shopping,” would be subject to anti-avoidance provisions, and therefore taxable in Australia.

At the time, both draft determinations were open for comments to be made to the ATO by interested parties. Such parties have called for clarification of the ATO demand, arguing that the uncertainty would deter offshore investors from participating in IPO and other capital market offerings in Australia. All such comments were to have been received by January 29, 2010, but the ATO has yet to make its final determination.

While stressing that it is the proper role of the ATO, as an independent office, to provide its view on how the current tax law operates, Sherry also underlined that “the government is looking closely at the draft determinations, and is closely considering representations from industry and advice from the Treasury before determining what action, if any, may be needed.”

He said that, while the government encourages foreign investment and actively seeks to promote Australia as a financial services centre, as demonstrated, for example, by its actions on withholding taxes, controlled foreign company rules, and capital gains tax and managed investment trusts, “there is, nevertheless, a balance to be struck between the government's encouragement of foreign investment and financial services, on the one hand, and protection of the integrity of the tax system, on the other.”

“The community expects the tax system to be fair and equitable, and that businesses, whether large or small, will meet their tax obligations,” he continued. “It's important to be clear about the nature of a particular type of commercial activity, for example, whether it's of a passive nature that attracts special tax treatment, or is more akin to the carrying out of a business operation or commercial transaction entered into with the intention of making a profit from that operation or transaction.”

“The government and our tax treaty partners,” he added, “are concerned to ensure that complex financial structuring involving tax havens is not used to skirt around our double tax treaties or our domestic tax laws.”