Structural advantages

In December the Australian Taxation Office issued a draft determination which said returns on Australian investments made by foreign private equity firms might be liable for income tax, regardless of whether the investment in question was owned by an offshore holding company. The ATO has said its decision to levy such a charge will depend on a number of factors specific to each individual deal and investor base – and has yet to issue any further clarifications.

Katherine Woodthorpe, chief executive of the Australian Private Equity and Venture Capital Association (AVCAL), says the draft ruling leaves industry participants “with ongoing uncertainty and reduces Australia’s attractiveness” to foreign investors. “If you’re not sure what the tax outcome will be, and for foreign investors it isn’t clarified, they have to price the uncertainty in their thinking,” Woodthorpe says. 

However, if funds qualify as a managed investment trust (MIT) or venture capital limited partner (VCLP), they may avoid the uncertainty. Private equity funds in Australia have typically been structured as either as trusts, venture capital limited partnerships or a combination of both. “Use of an MIT or VCLP for foreign LP investment would generally overcome the issues arising from the ruling,” says Toby Eggleston, director at tax advisory firm Greenwoods & Freehills.

VCLP qualification affords two benefits. “Non-resident investors are not subject to tax on gains made by the VCLP; and secondly, the carried interest is deemed to be a capital gain, and so when ultimately paid to individuals, can be discounted by 50 percent under the capital gains tax (CGT) discount rules,” Eggleston says.

He adds that GPs using an MIT structure enjoy capital gains tax rates on proceeds from investments, but the downside of the structure is that carry is considered ordinary income and does not benefit from the CGT discount.

Meeting the standard for either qualification, however, is challenging. The ability of a foreign fund to establish an Australian MIT will depend on, among other things, the structure of the foreign PE fund – whether or not it is itself a trust or a limited partnership – and its investor types.

Woodthorpe says fulfilling these requirements, however, is “easier said than done”.

“You have someone like a large fund of funds who is an investor, well then who are their investors? How do you persuade overseas entities of the complexity of a large fund of funds to give up information on who their investors are?”

Woodthorpe also stresses that though legislation regarding private equity taxation practices continues to be hazy, investors should not be turned off.

“Australian private equity is still delivering excellent returns, we should still be considered a superior or excellent investment destination,” she says. “We are still well and truly open for business.”