ATO rulings spark fear over future of foreign capital

Private equity insiders say the Australian Tax Office's push for tougher taxation rules on foreign private equity investors could also impact investment in other asset classes, including infrastructure.

The release yesterday by the Australian Taxation Office (ATO) of two draft determinations proposing a toughening of the taxation rules on foreign private equity investors has prompted concerns foreign capital could “retreat significantly” from a range of asset classes.

In a strongly worded statement, Katherine Woodthorpe, CEO of the Australian Private Equity & Venture Capital Association (AVCAL), said if the rulings were allowed to pass unchallenged there would likely be “a significant, long-term detrimental impact on a range of sectors including private equity and infrastructure”.

She went on to say foreign investment in Australia would likely decline as a result. “There are already numerous examples of international investors standing back waiting for the government to clarify its policy intent.”

Mark Stanbridge, a Sydney-based partner at Blake Dawson, said a potential rule change “really creates problems for Australia as an investment destination because whatever logic you apply here to private equity, it’s going to apply to other sectors as well. It creates sovereign uncertainty with relation to Australia, which has always been a very safe place to invest because people have always had certainty around how these things are dealt with.”

The ATO has focused on two issues in its draft rulings. Firstly, whether private equity profits should be counted as income rather than capital gains and taxed accordingly at a higher rate; and secondly, whether an ownership structure employing more than one offshore company for no commercial reason could be considered as a tax avoidance strategy and exempted from any tax treaties in place. In both cases, the ATO has ruled the answer is “Yes”.

On the first issue, the independent government body cited the example of the purchase of an Australian target company by a Dutch holding company, in turn owned by a Luxembourg entity, which itself is owned by a Cayman Islands entity. “There are no commercial reasons for using a Dutch company … although there is a tax benefit in having the profit derived from the sale of the group by a Dutch company rather than the Cayman Islands entity because of the Australia-Netherlands tax treaty,” it said in a statement.

On the second issue, the ATO stated: “If [the firm] 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 will constitute ordinary income.”

Although no direct reference was made to TPG Capital in the ATO’s drafts, it is clear the rulings have come as a direct result of the debate between the US firm and the organisation over the tax payable on the returns from the recent IPO of TPG portfolio company Myer Group. In fact, the examples given by the ATO directly mirror the structures used by TPG and the chain of department stores, which listed on the Australian Securities Exchange at the start of November.

Following the company’s flotation, which reportedly netted TPG $1.48 billion in profits, the ATO claimed the firm owed it A$452.2 million ($422.7 million; €282.3 million) in unpaid capital gains taxes and a $226.1 million tax avoidance fine.

TPG, which used a chain of entities based in the Netherlands, Luxembourg and the Cayman Islands to facilitate its holding of Myer Group, disputed the claim and subsequently won a high court hearing allowing it to take its proceeds offshore untouched.

The ATO draft rulings are open for public comment until 29 January, after which time the body will finalise its stance on the issues.