Nothing stirs a tax authority into action in Asia like the sight of a US private equity firm making a highly lucrative and tax-free exit on its shores.
Precedents include Japan’s famous “Shinsei Tax”, imposed on private equity in 2005 in reaction to the $5 billion raked in by Ripplewood Holdings and JC Flowers tax-free via their turnaround and divestment of the country’s Shinsei Bank (formerly Long-Term Credit Bank of Japan).
More recently, the South Korean tax authorities have revived discussions of placing a capital gains tax on US private equity firms exiting deals there. The move is believed to be directed at Texas-headquartered Lone Star Group, which is primed to exit its stake in Korea Exchange Bank (KEB) later this year after years of controversy and legal wrangling over the KRW1.38 trillion ($1.2 billion) purchase of the bank in 2003.
But while investors in most Asian markets anticipate some unpredictability around the government’s attitude to private equity, and the regulatory and tax regime under which they operate, they expect things to be different in Australia.
The country’s reputation as an investor-friendly destination, with a supportive government and a solid tax regime, has kept it at the forefront of Asia’s buyout market and enabled it to hold its place among the top investment destinations for private equity capital entering Asia, behind China and India. This despite lacking the alluring economic growth of some of its emerging neighbours.
However, this perceived attractiveness has been put on the line – and with it foreign investor confidence – by the Australian Taxation Office (ATO), which is pushing for stricter rules on the tax paid (or not paid, according to them) on private equity transactions and private equity business in general. And once again, it all started with a US firm, in this case TPG, and a highly lucrative exit.
In November, the ATO presented TPG with a tax bill for $678 million on its reported $1.48 billion profit from the IPO of department store chain Myer Group – a bill that TPG successfully disputed.
But something that started small took on a life of its own in December when the tax body issued a draft proposal suggesting the suspension of tax treaties when offshore holding companies are used to structure a transaction for “no obvious commercial reason”. In a separate proposal, the ATO also suggested private equity revenues be taxed as income rather than capital gains.
The potential for these proposals, if passed, to seriously curtail all foreign investment – not just private equity – into Australia was underlined by the Australian Private Equity & Venture Capital Association (AVCAL) in its submission to the ATO on 29 January. AVCAL also argued that the proposals threatened to “unwind” government efforts to promote the country as a financial services hub, and to contravene long-standing OECD tax agreements.
The furor is catching attention globally. Although The Blackstone Group has never invested in Australia, the firm’s co-founder Stephen Schwarzman was moved to comment at the recent Davos summit that the current uncertainty will “dramatically chill any future investment until this matter is resolved one way or the other”.
Though others do not doubt that investment into Australia will continue, there is acknowledgement that investors will now take a pause for thought.
“What a sponsor – or any investor – wants is a highly predictable tax regime so they can deliver returns efficiently to investors,” said one Asian mezzanine provider currently working on a transaction in Australia. “The ATO proposals, while they don’t change the law, have put fear into investors because they bring in an element of unpredictability.”
So why did the ATO set out to challenge the status quo? Did it realise that in chasing a single private equity firm it might relieve Australia of one of its most attractive investment features? As things stand now, the baby is in danger of being thrown out with the bathwater.
According to media reports Austrade, the Australian Trade Commission, has been quietly polling global buyout firms since the ATO drafts to gauge their reactions to the tax body’s actions. The results of that survey have not yet been made public.
But with the ATO due to announce its conclusions on the private equity tax issue on 5 May, someone up high better take action – and quick – if Australia doesn’t want to lose its reputation as an investor-friendly destination, and gain the one of unpredictability held by many of its Asian peers.