Income taxation issues
The main income tax issues relate to financing the acquisition (where the bidder is an Australian company) and exit strategy. For interest expenses to be deductible, borrowings (generally including subordinated debt) are required to be used for income producing purposes. Preference shares and other forms of equity issued by a bidder may also qualify as ‘debt interests’ for tax purposes (depending on the terms), in which case dividends paid or accruing on such shares may be deductible to the bidder. Interest expenses incurred by the bidder cannot be set off against the target’s net income for tax purposes unless the bidder and the target are part of the same tax consolidated group. This requires the bidder to acquire all the shares in the target and be an Australian resident company for income tax purposes.
In many instances, such as where the bidder is controlled by non-residents or where the target has overseas subsidiaries, the level of ‘debt’ financing must satisfy thin capitalisation rules (which limit deductions for excessive ‘debt’ funding). A safe harbour is permitted for interest-bearing debt up to 60 per cent of the difference between assets and other non-interest-bearing liabilities (approximating a debt to equity ratio of 1.5:1). More generous thin capitalisation limits apply for banks and other financiers. An arm’s-length debt test and a worldwide gearing test may allow a greater level of debt. Transfer pricing rules may also be relevant in determining allowable levels of debt and the interest rate on that debt.
Generally, interest and dividends (subject to certain exceptions) paid or credited to non-residents are subject to withholding taxes. There are some limited exceptions to the payment of withholding taxes on interest where certain qualifying debt instruments or syndicated loan facilities are publicly offered or under certain tax treaties where the loans are made by certain qualifying financial institutions.
Gains made by private equity funds and their investors are typically considered to be on revenue account (rather than capital account) where the relevant fund or investor intends to make a profit from the sale of the investment (rather than by holding the investment and deriving regular income). Where the fund or investor is a non-resident, Australia will tax that gain if it has an Australian source and is not prevented from doing so under an applicable treaty.
Where the gain is considered to be on capital account (for example, where some deeming rules operate in respect of specific private equity fund structures or in the case of non-private equity investors), non-resident investors are exempt from tax on gains made on a disposal unless the gain is referable predominantly to Australian land interests.
The Australian Taxation Office (ATO) has expressed its views on some of these issues, including the following:
- that gains made by foreign private equity entities can in particular circumstances (which are likely to apply to most private equity structures) be treated as ordinary income (and are not eligible for the non-resident capital gains tax exemption) and are therefore taxable in Australia where those profits have an Australian source;
- anti-avoidance provisions can apply to common foreign investment structures where interposed entities are used to access the benefits of Australia’s treaty network (namely, treaty shopping);
- a ‘safe harbour’ is provided for foreign investors investing into Australia through foreign limited liability partnerships in particular circumstances where those foreign investors are able to access relevant tax treaty benefits; and
- the source of gains made by a private equity fund will not depend solely on where the purchase and sale contracts are executed (that is, regard will be had to factors such as the place in which the relevant entity operates, the location of its central management and control and from where it derives its profits).
If a non-resident disposes of certain interests (including shares in a company or units in a trust), the value of which is predominantly derived from Australian land, the purchaser will be obliged to withhold and remit to the ATO 12.5 per cent of the proceeds from the sale. It should be noted that not only will this withholding apply to the taxation of capital gains, it will also apply where the disposal of the relevant asset is likely to generate gains on revenue account, and therefore be taxable as ordinary income rather than as a capital gain. This withholding is not levied as a ‘final’ withholding tax and a tax offset or tax refund (where relevant) for the withholding may be available on lodgement of the non-resident vendor’s Australian income tax return.
Where a transaction by a foreign person is notifiable to FIRB, it is not unusual to have tax conditions imposed on the transaction to ensure compliance with tax laws. The ATO uses this process to obtain additional information on tax matters associated with the transaction and any existing investments.
The tax consolidation rules effectively treat entity acquisitions as if they were acquisitions of the underlying assets. Opportunities exist to achieve a step-up in the cost base of various assets for income tax purposes if all the equity in a target is acquired by a bidder that is an Australian resident company and that is part of a tax consolidated group or that subsequently makes an election to form a tax consolidated group. However, ‘step-downs’ in tax bases can also occur (eg, if acquired asset values are lower than their tax written down value). Whether this step-up or step-down has a material impact on the tax profile will depend on the type of assets that are affected.
Under the tax consolidation rules, where the deemed purchase cost is allocated to inventory, this would shelter future gains on sales of that inventory from tax. Likewise, where it is allocated to depreciable assets (eg, equipment), this would have the effect of increasing deductions for depreciation charges. Amortisation of goodwill is not deductible for Australian income tax purposes.
Indirect taxation issues
The main indirect tax issues relate to stamp duty and goods and services tax (GST).
With respect to stamp duty, there are three heads of duty that generally apply in the context of private equity transactions:
- landholder duty - for dealings in shares and units, including share/unit purchases and share/unit subscriptions;
- private unit trust duty - for dealings in units only; and
- transfer duty - for asset purchases.
Acquisitions of significant interests in an Australian or foreign entity that holds, directly or indirectly, land interests in Australia equal to or above a particular value threshold (ie, is a landholder) are subject to landholder duty in the relevant Australian jurisdiction. The significant interest and landholding thresholds vary from jurisdiction to jurisdiction, depending additionally on whether the target entity is listed or unlisted, but generally a significant interest is a 50 per cent or greater interest for acquisitions in unlisted entities and a 90 per cent or greater interest for acquisitions in listed entities, and the landholding value threshold ranges from A$0 to A$2 million. Please note that land interests are also varyingly defined in broad terms, and can include things attached to the land regardless of whether they constitute fixtures at common law.
Private unit trust duty
Acquisitions of any units in an unlisted trust that holds, directly or indirectly, ‘dutiable property’ (as varyingly defined and outlined below) in Queensland irrespective of the percentage threshold, may be subject to private unit trust duty in that jurisdiction.
Transfers, and (for most jurisdictions) agreements for the transfer, of dutiable property are subject to transfer duty in the relevant Australian jurisdiction. Dutiable property is varyingly defined, but generally includes land interests and may further non-exhaustively include intangibles (such as goodwill and intellectual property), plant and equipment, trading stock and trade debts.
Please also note that, in addition to the heads of stamp duty discussed above, certain Australian jurisdictions have begun, or are scheduled to begin, imposing a stamp duty surcharge on certain share, unit and asset acquisitions by foreign purchasers that involve residential land. A foreign purchaser is varyingly defined but broadly is in accordance with the definition of ‘foreign person’ for the purposes of FIRB approval as discussed in question 5.
With respect to GST, supplies of goods or services made by entities that are registered for GST generally attract GST (similar to value added tax) subject to the discussion below. GST is imposed at the flat rate of 10 per cent and, under the GST law, is a liability of the supplier, but is typically passed on to the recipient. However, in the context of private equity transactions, the following GST treatment may apply:
- ‘input taxed supplies’ for dealings in shares/units: where the supply is an acquisition of an interest in or under shares/units, that supply is input taxed such that no GST will be payable on it. However, the supplier and recipient may not be able to recover the GST costs (in the form of input tax credits) associated with that supply and acquisition respectively; and
- ‘GST-free supply of a going concern concession’ for asset purchases: where the assets are acquired as part of a going concern (in effect, a continuing business), that supply is GST-free, such that no GST will be payable on it. However, unlike input taxed supplies, the supplier of a GST-free supply is entitled to recover the input tax credits associated with that supply. Please note that if this concession does not apply, the asset purchase may give rise to a taxable supply that is subject to GST.
General anti-avoidance issues
Australia has very far-reaching anti-avoidance rules in the context of both direct and indirect taxes, including multinational anti-avoidance law and diverted profits tax directed at multinational corporations and general anti-avoidance provisions. Accordingly, all transactions need to be considered in the context of the risk posed by those rules.
Australia recently enacted hybrid mismatch rules that had a start date of 1 January 2019. Broadly, the rules are aimed at structured arrangements and arrangements between related entities that result in:
- a deduction in one jurisdiction for a payment that is not assessed as income in the recipient jurisdiction; or
- a deduction in two jurisdictions for the same payment.
The above outcomes can arise where transparent entities (which are commonly used in private equity structures) are involved in arrangements.
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