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ATO Issues Draft Determination On Private Equity Asset Sales

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

21 December 2009


The Australian Taxation Office (ATO) has issued two draft tax determinations regarding the two main questions behind its AUD678n (USD610m) claim for tax and penalties following the sale of the Myer department store group by a private equity group using tiers of foreign ownership.

The ATO considers that a private equity entity can make an income gain subject to company tax from the disposal of the target assets it has acquired. If the 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, due to the regularity and repetition and size and scale of its activities, the profit from the disposal of shares in the Australian public company would constitute ordinary income.

Furthermore, even if an entity’s profit from this arrangement is from an isolated transaction (for example, where it is a special purpose vehicle that carries out only this one operation), the ATO still considers that transaction as being entered into in the course of carrying on a business and, consequently, the profit would be subject to company tax.

However, its draft determination in that respect reiterates that, where the private equity entity that has acquired Australian target assets is a resident of a country with whom Australia has a tax treaty, the business profits article in the relevant treaty will determine which country has the taxing rights in respect of that profit.

As it is generally the case, it says, that the country of residence of the profit maker will be entitled to tax those profits, it confirms that non-resident private equity entities in treaty countries will not usually be subject to tax on such Australian business profits.

The ATO also reiterates that, if the profit is not ordinary income, a capital gain or capital loss from the disposal of most CGT assets is disregarded for Australian income tax purposes if made by a non-resident of Australia.

The ATO’s second determination, however, then goes on to say that, if the above-mentioned profit made by a private equity group is considered as taxable income, any arrangements in making that profit which are designed with the sole purpose of altering the intended effect of Australia's international tax agreements network, or using so-called “treaty shopping,” would be subject to the anti-avoidance provisions of the Income Tax Assessments Act, and therefore taxable in Australia.

The example it gives of such treaty shopping is relevant to the arrangements within the Myer transaction. The ATO describes a situation where a Dutch holding company of a newly incorporated Australian company acquires all of the shares in an Australian manufacturing company (the Target). An Australian consolidated tax group is then formed.

In the example, the Dutch holding company is in turn owned by a Luxembourg entity that is itself owned by an entity resident in the Cayman Islands. Various US resident investors and a private equity group control the Cayman Islands entity.

Their primary purpose for acquiring the Target is to improve its business operations in the short term and then sell the consolidated group via an initial public offering for an amount greater than the purchase price.

There are, the ATO says, no commercial reasons for using a Dutch company and a Luxembourg company as intermediate entities in the ownership chain, although there is a tax benefit in having the profit derived from the sale of the group by a Dutch company rather than the Cayman Islands entity because of the Australia-Netherlands tax treaty in relation to business profits sourced in Australia.

The ATO concludes that, in the absence of commercial reasons for the interposition of the Dutch and Luxembourg entities between the Cayman Islands entity and the Australian company, the dominant purpose of the scheme of acquiring the Target in the manner undertaken is to obtain the tax benefit. The profit, to be treated as business income, would then be subject to Australian company tax.

Both draft determinations are now open for comments to be made to the ATO by interested parties. Such comments are to be received by January 29, 2010.

A comprehensive report in our Intelligence Report series, titled "Offshore For Corporates", discusses in depth the comparative merits of offshore HQs, with a Corporate Treasury section analysing how to get an optimal blend of tax-efficiency and profits and finally a study into how two types of international business can use onshore low-tax regimes in parallel with offshore jurisdictions to construct highly tax-efficient corporate structures, 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_report7.asp

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