Australian Private Equity Awaits Tax Ruling

by Mary Swire, Tax-News.com, Hong Kong

27 October 2010

According to the 2010 Yearbook issued by Australian Private Equity and Venture Capital (AVCAL), investors continued to take a cautious approach to new commitments and this, combined with heightened uncertainty over the tax treatment of private equity (PE) profits, saw fundraising activity slowing markedly during the year.

The year, it was said, was a period of consolidation and gradual recovery for the Australian PE and venture capital (VC) industry. Although fundraising remained muted, a total of ten PE funds raised almost AUD1.5bn (USD1.44bn) during the 2010 financial year, 3% higher than the previous year.

However, consistent with the experience of the VC industry in general throughout the rest of the world, AVCAL confirmed that Australian VC continued to face substantial hurdles in raising new commitments. In addition, a significant proportion of both PE and VC investment was in the form of follow-on investment rather than new deals, reflecting the industry’s focus on maintaining a steady line of support for existing investees.

On divestments, AVCAL reported that there were 60 exits of 49 companies in FY2010: slightly higher than the 54 exits of 37 companies the previous year. Notably, public offerings returned as a means of divestment, with three companies exited via IPOs and seven via the sale of quoted equity, compared to none at all in FY2009.

Overall, therefore, AVCAL considered that there are signs of a gradually-improving market for PE and VC investments and exits. Fundraising activity, while slower to pick up, it said, should gain some traction as more successful exits are made and investors are better able to quantify and benchmark the performances of individual funds and fund managers.

However, AVCAL pointed out that some clouds on the horizon remain of much concern to investors – particularly the continued uncertainty over the tax treatment of PE proceeds – and mean that continued recovery will largely depend on how that issue develops.

In that respect, AVCAL is referring to the outstanding draft determinations made by the Australian Taxation Office (ATO) in December last year, claiming AUD678m in tax and penalties following the sale of the Myer department store group by a consortium led by TPG.

The ATO then provisionally ruled that, if an entity does not have the intention of becoming a long-term investor to derive dividend income from its shares, and if it is carrying on a business of restructuring and floating companies, the profit from the disposal of shares in an Australian company would constitute ordinary income, not capital gains, and be taxed at income tax rates.

The draft determination raised doubts in the minds of investors about the suitability of undertaking business in Australian markets. There have since been calls, of which AVCAL’s is only the latest, for the urgent clarification of the ATO’s claim, arguing that the continued uncertainty would deter investors.

The publication of the ATO’s final rulings was expected at various times in the first half of this year. The last expected date was May 26, but the ruling was then further deferred. There has been no subsequent official indication when it can be expected but, given the interest of the government in the outcome, possibly leading to corrective legislation, it was obviously found to be impossible before the August elections.

While any present calculations by investors need to factor in the still-existing tax risk, there has recently been some indication that the ATO’s ruling could be expected to be given before the end of this year.

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