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Under specific tax laws applying to foreign entities undertaking acquisitions in Australia, there may be a requirement to seek a ‘no objection’ approval from the FIRB.
The government has been growing FIRB’s compliance arm for several years. The Australian Taxation Office (the ATO) has a dedicated team that is consulted by the FIRB when an application is made to the FIRB. The ATO will provide a risk rating of ‘low’, ‘medium’ or ‘high’. Among other factors, this rating will be based on the structure being used by the PE investor.
Based on this assessment, the FIRB can apply ‘standard’ tax conditions to the application. Further, if a proposed investment is considered to have a significant or high tax risk, then ‘additional’ tax conditions may also be imposed. If tax conditions are imposed, investors will have reporting and compliance obligations.
The investor may need to supply certain information, enter into good faith negotiations with the ATO for an advance pricing arrangement, to request a private binding ruling, or to take other action to resolve tax issues.
Foreign investors will be expected to work with the ATO in complying with any conditions. The final investment approval will be subject to the tax conditions being met and the investor being able to demonstrate compliance.
On recent transactions, foreign private equity funds looking to invest in Australian assets are being imposed with unprecedented tax disclosures and stricter tax conditions.
FIRB can request ‘all tax advice’, including draft versions be provided. Documents reviewed will include ‘all step plans, diagrams, agreements, financial models and documents explaining commercial rationale.’ There has also been a trend on private equity deals, for an extra tax condition – ‘to inform the ATO/FIRB in advance before looking to exit from the investment.’
Funds with structures in tax havens can be being asked to justify the rationale for the use of such structures. The broad line of enquiry is to consider if a ‘reasonable amount of tax’ is paid somewhere in the world.
Since 1 July 2023 foreign investors are required to register a broad range of assets with the ATO. The registration is done via an online portal and within 30 days of acquiring the asset. The registration process is complex, and we have seen numerous challenges where foreign persons attempt to access to the Online Services system.The ATO has now commenced reviewing the portal. Potential penalties for non-compliance can be punitive.
Recent changes have been announced whereby a more risk-based approach is taken on applications. More resources will be devoted to high-risk applications. Foreign investment proposals with certain tax characteristics likely to be considered higher risk, include:
One of the more difficult areas of Australian tax law is the capital-income dichotomy. This applies not just to private equity but to all taxpayers. For PE transactions the question is, will a future exit be on capital account or income account?
The legislation does not contain a bright line test, and the Australian tax system has relied on court decisions which have provided the relevant criteria used to analyse against the facts. It can be difficult to conclude without some uncertainty remaining. Advisers generally need to weigh up all relevant facts and circumstances against the case law guidance.
In relation to private equity investments, the ATO acted a few years ago against a fund managed by Texas Pacific Group (TPG) in relation to the sale of shares in Myer. Following the TPG case, the ATO issued a Tax Determination (TD 2010/21), which considered that a gain in a PE transaction can be classed as a revenue gain if examination of the facts and circumstances show that it is, broadly, a business gain or an isolated transaction to make a profit or gain or made in carrying on a commercial transaction.
The Commissioner’s default position is that gains on disposal of investments by PE entities are characterised as ordinary income for tax purposes rather than capital, unless the Commissioner can be convinced otherwise based on the particular facts and circumstances.
The Tax Determination noted that the revenue/capital classification will ‘depend on the circumstances of each particular case’, assessing the significance of the gain on disposal against other benefits from the investment including dividend flows and cash flow from operations.
Where a foreign resident PE firm makes a gain from exiting their investment in Australia and the gain is on capital account, the next question is whether the non-resident disregard the capital gain.
Foreign residents continue to have access to an exemption from Australian CGT in respect of gains on sale of Australian shares where the underlying business does not have a close economic connection to Australian land and/or natural resources. This is consistent with international practice and Australia’s international tax treaties.
Specifically, the CGT exemption rules can apply to disregard a capital gain or capital loss on disposal of Australian shares made by a foreign resident if – less than 50 per cent of the value of the Australian shares were derived from real property such as land, an interest in land or mining rights.
In September 2024, significant changes are proposed to the foreign resident CGT reduction regime. Treasury is of the view that the definition of ‘real property’ as currently applied does not adequately capture assets with a close economic connection to Australian land and/or natural resources. Examples are tangible assets such as telecommunications or energy infrastructure and intangible assets such as water rights or pastoral leases. Investors in these sectors should monitor the impact of these changes closely.
FRCGW tax is applied to foreign resident PE sellers who dispose certain taxable property, including taxable real property with a value of $750,000 or more, and other assets such as indirect Australian real property interests in Australian entities.
Currently, the regime obliges purchasers to withhold 12.5 per cent of the purchase price from the vendor, and instead remit that to the ATO. At the time of writing (September 2024) the Government has announced the FRCGW tax rate will be increased from 12.5 per cent to 15 per cent and the withholding threshold will be reduced from $750,000 to $0.
Foreign PE sellers need to be aware that the purchaser may need to withhold 12.5 per cent from the purchase price. Steps can be taken to remove this withholding where the PE seller does not have an Australian tax liability from the sale.
Where a foreign resident PE firm makes a gain from exiting their investment in Australia and the gain is on income account, the next question is whether the non-resident can disregard the gain under any applicable double tax treaty.
The Permanent Establishment article of most tax treaties broadly provides, that the profits of a foreign private equity entity shall not be taxable in Australia unless the entity has a permanent establishment in Australia.
Australia’s Tax Treaties can have a Principal Purposes Test (PPT) test under which treaty benefits can be denied if, ‘it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes…’
Accordingly, where one of the principal purposes of an arrangement is to obtain the relevant treaty benefit and another of its principal purposes is to achieve a particular commercial objective, the test for denial of benefits will be met, without the need to determine which purpose is dominant. It is not a sole, dominant or primary purpose test.
On the other hand, where the arrangement can be fairly described as an ordinary commercial dealing and its form has not been driven by considerations around treaty benefits, the arrangement will not have the requisite purpose even though its effect is to obtain treaty benefits.
Further, the ATO has also issued a Tax Determination (TD 2010/20) stating that the involvement of tax treaty entities in international ownership chains can be disregarded by the ATO under the general anti avoidance provisions in the Tax Act (Part IVA). The Determination notes that where an arrangement is put in place merely to attract the operation of a particular tax treaty any tax benefits obtained in relation to such scheme may be cancelled.
At a practical level, it means:
If the gain is on revenue account and treaty relief is not available (e.g. the ATO considers treaty shopping had occurred) the gain will only be taxable in Australia to the extent that the profits are from an Australian ‘source’. The source of the gain must be determined having regard to all the facts and circumstances of the particular case.
It’s not helpful that there is no definition in the Australian Tax Act as to how the source of a gain should be determined instead release is place on published guidance and decided cases.
In the context of the sale of shares, the question of ‘Australian source’ is not dependent solely on where purchase and sale contracts are executed. Rather, it must be determined having regard to all the facts and circumstances.
Based on case law in the area, some of the factors that must be considered when determining source are:
There are several GST implications surrounding foreign investments into Australia that can lead to risks of material tax shortfalls and ATO compliance activity when overlooked in the planning stages. As GST is a ‘transactional’ tax, it is necessary to consider the GST-related impact of each step within a transaction process. Any entities making ‘supplies’ for GST purposes will need to ensure that GST is being reported correctly on taxable supplies that may be made as part of the transaction process. For example, transfers of assets, even if they are part of a broader transaction that involves making financial supplies (such as share and unit transfers), can be subject to GST.
While GST is not applicable to financial supplies, investors will need to ensure that the correct GST treatment is being applied on transaction costs as the GST rules operate to restrict an entity’s entitlement to claiming GST credits on costs that are subject to GST, to the extent that those costs are incurred for the purposes of making financial supplies (for example, Australian legal fees incurred by an entity acquiring shares in another Australian company).
There are complex GST rules and stringent anti-avoidance measures that apply in this space, particularly in relation to cost recharges and even acquisitions of services from non-resident vendors that may be subject to ‘reverse charge GST’ that must be self-assessed by the entity incurring the cost.
The Australian Taxation Office continues to focus heavily on tax structures that are put in place for foreign PE investment into Australia. In addition, if FIRB approval is needed, there will be ATO/FIRB review of the proposed structure. FIRB will likely review all tax advice received and seek to impose tax conditions to approvals.
Australia has stringent treaty shopping and anti-avoidance laws; investors should ensure they obtain tax advice from an early stage to ensure compliance with all aspects of Australian tax laws.
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