by Mary Swire, Tax-News.com, Hong Kong Thursday, May 27, 2010

The Australian Tax Office (ATO) has deferred for a third time a final determination and clarification of its decision to tax "income" of private equity firms' investments in Australia, where these were perceived to be capital gains. A tax office spokesperson said the government was reviewing its policy in this general area.

The ATO had issued a draft ruling on December 16, last year requiring proceeds from asset sales to be taxed as ordinary income, at the 30% corporate rate, instead of as a capital gain, which would have been tax-exempt for foreign investors or at a concessionary rate for local investors.

The background to this determination was the issuance by the ATO of a AUD452m (USD400m) tax demand on an offshore private equity fund behind the Myer department store float. The ATO was particularly exercised by the ownership structure of the department store group, Myer Holdings, with its three tiers of foreign ownership under the auspices of the TPG private equity group. The three tiers started with a Netherlands company, NB Swanston, owned by the Luxembourg-based NB Queen SARL, and then the Cayman Islands-registered TPG Newbridge Myer at the top of the ownership tree.

Australia's tax treaty with the Netherlands provides for income tax to be paid in the investing company's domicile, but EU tax rules allow tax exemptions on dividends received from outside the EU. Since there was no double taxation treaty with Luxembourg, there would have been no tax relief without the Netherlands company's juxtaposition within the ownership structure. The ATO used general anti-avoidance provisions of the Tax Act to impose a 30% corporate income tax on an estimated AUD1.5bn profit from the sale of Myer shares and another AUD226m as an avoidance penalty.

In February this year Australian venture capital leader, Dr Katherine Woodthorpe, said: “The federal government must clarify the circumstances in which private equity funds are able to generate capital gains for their investors. Without clarity on this front, foreign investors will be unable to secure the intended outcome of the 2006 amendments to Australia’s tax laws, which determined that capital gains earned by foreign investors be taxed in the hands of those investors in their country of residence. The 2006 amendments brought Australia into line with other OECD countries."

There was reportedly no government review taking place that could hold up the ATO's final determination which was due on May 26, and no time-frame given for its publication. Dr Woodthorpe said it was likely that foreign investment into Australia would retreat significantly, and that international investors had been standing back waiting for the Australian government to clarify its policy intent.

A comprehensive report in our Intelligence Report series examining tax-sheltering arrangements for investors, including Venture Capital, Forest Finance and Film Finance in a number of key jurisdictions, is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report5.asp

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