The intricacies surrounding foreign private equity investment into Australia remains a central focus area for regulatory bodies including the Australian Tax Office (ATO) and the Foreign Investment Review Board (FIRB).
Treasurer Jim Chalmers has expressed support for this emphasis highlighting that his proposed FIRB reforms are aimed at intensifying scrutiny over foreign private equity investment via a request for unprecedented tax disclosures and imposing strict tax conditions1.
Where a private equity investor disposes of an asset that it holds on 'capital' account and such an asset is not taxable Australian property, then any Australian capital gain resulting from the disposal may be disregarded. Alternatively, where an asset that is on 'revenue' account is disposed of by a non-resident investor, then the gains realised on disposal should be treated as a revenue gain or ordinary income and would be taxable in Australia where the gain is considered to be Australian sourced and treaty protection is not available under a double taxation agreement (DTA).
Where a private equity investment is deemed to be held on revenue account, the ATO is primarily focused on determining the source of gains realised by foreign resident private equity investors. The determination of whether income or gains are sourced in Australia depends on various factors such as the location of the underlying assets and underlying economic activity, the place of performance of services, the place of contract, and the residency status of the taxpayer. In a private equity context, this is likely (but not limited to) the place of negotiation of sales, whether any offshore executives visited Australia to manage the ongoing business and/or sale of the investment, and where instructions for business decisions were made. Where the concept of source applies, relief may potentially be granted (whether it be for the fund vehicle or more typically, the underlying investors) under the applicable DTA, assigning the taxing rights of Australian sourced gains to the entity's country of residency subject to certain conditions.
Of particular concern is the use of investment platforms by foreign private equity funds which invest via jurisdictions in which Australia has a DTA. Such arrangements may allow for profits derived from the sale of Australian assets to be distributed offshore without being subject to tax in Australia. However, it's crucial to note that the benefits of a DTA are only accessible to the extent that there is sufficient substance established in the treaty jurisdiction and that the asset is not considered to be indirect taxable Australian property. In this regard, it is worth acknowledging that certain investment manager regimes require a minimum level of activity in the jurisdiction of residence to access concessional treatment.
The ATO's focus in international private equity investment centers on three other key areas: the principal purpose test (PPT), diverted profits tax (DPT) and Part IVA of the ITAA 1936.
Principal Purpose Test: Unraveling Intentions Behind Transactions
The PPT assesses whether tax benefits are the primary motive behind transactions, particularly examining whether usage of treaty platforms for private equity investments is to avail of preferential tax treatments or to genuinely facilitate business operations. Where the ATO is not satisfied with the commercial reasoning offered for the interposed entity, denial of treaty benefits sought can arise resulting in the gain becoming fully taxable.
The Diverted Profits Tax: Balancing Fairness and Compliance
The DPT, enacted in 2017, targets multinational profit-shifting tactics, scrutinising arrangements that divert profits from Australia through artificial means. For international private equity funds operating through treaty platforms, the ATO carefully analyses whether the structures in place are genuine commercial arrangements or designed primarily for tax avoidance purposes.
Part IVA: Addressing Tax Avoidance
Part IVA of the ITAA 1936 allows the ATO to counteract tax avoidance, and focus on transaction substance rather than legal form, which is essential for evaluating whether private equity structures via treaty platforms serve legitimate business purposes or aim to circumvent Australian tax obligations.
In contrast to the PPT, if an alternative argument can be effectively mounted to demonstrate that a particular interposition of entities did not yield any tax benefits beyond what would have been achieved in a direct arrangement, Part IVA may not apply. This scenario is particularly relevant for treaty platform investors who are themselves residents of a treaty jurisdiction. In such cases, if these investors were to invest directly, they would likely be eligible for the same concessional treatment provided by the relevant double tax agreement.
This underscores the principle that Part IVA is intended to address instances where taxpayers engage in artificial or contrived schemes with the dominant purpose of obtaining a tax advantage.
Conclusion: Toward Transparency and Compliance
The ATO's current attention to international private equity investments via treaty platforms highlights the significance of transparency, substance, and adherence to regulations in cross-border dealings.
These are relatively new concerns, not in the sense that the law has changed, but in the sense that the ATO is now paying a lot of attention to source and the use of international platforms.
International private equity funds should be cognisant of the ATO's concern when considering investing in Australia and addressing these concerns proactively is crucial. Partnering with knowledgeable tax advisers familiar with Australian tax laws, maintaining comprehensive records of commercial substance in investment structures and the ongoing management of substance protocols is paramount for risk management and tax compliance. Such efforts help foster trust with tax authorities and help to contribute positively to Australia's economic landscape.
Footnote
Originally published 17 June 2024
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