Forms of vehicle
What legal form of vehicle is typically used for private equity funds formed in your jurisdiction? Does such a vehicle have a separate legal personality or existence under the law of your jurisdiction? In either case, what are the legal consequences for investors and the manager?
The most common vehicles for establishing private equity (PE) funds in Australia are the unit trust (including two special forms of unit trust known as a managed investment trust (MIT) or an attribution managed investment trust (AMIT)), the venture capital limited partnership (VCLP) and the early stage venture capital limited partnership (ESVCLP).
A unit trust is a contractual (and fiduciary) relationship created between the unitholders (investors and beneficiaries) and the trustee (legal holder of the property) under a trust deed or constitution. The trustee generally has the right to deal with the assets of the trust in accordance with the terms of the trust deed governing the trust for the benefit of investors.
The unit trust is not a separate legal entity and the trustee contracts on behalf of the trust, subject to a contractual term generally limiting liability of the trustee to the assets of the trust.
See question 17 regarding the tax treatment of unit trusts.
A MIT is a unit trust (as described above) that has certain characteristics. To qualify as a MIT for a particular income year, a number of tests must be met, including (but not limited to) the following:
- the trustee must be an Australian resident for tax purposes;
- the trust must not be a trading trust (a trading trust is one that carries on, or controls an entity carrying on, a trading business);
- a substantial proportion of the investment management activities carried out in relation to the trust throughout the income year must be carried out in Australia in relation to certain assets (this requirement is only relevant for the MIT withholding regime, which is described below);
- the trust must be a ‘managed investment scheme’ for Corporations Act purposes at the time the first fund payment is made;
- the unitholding must be widely held and satisfy concentration of ownership requirements; and
- in certain cases, the trust must be operated or managed by a licensee holding an Australian financial services licence (AFSL) whose licence covers it providing financial services to wholesale clients.
The MIT regime addresses issues surrounding uncertainty about the tax treatment of gains made by unit trusts. See question 17 regarding the tax treatment of MITs.
The AMIT regime is an elect-in regime which, among other things, makes the following available to eligible AMITs:
- an attribution method (rather than the existing trust tax rules) to attribute specific classes of income, offsets and credits to unitholders, based on their entitlements;
- the ability to attribute any under or over distributions to unitholders during the income year the discrepancy is discovered;
- tax treatment as a fixed trust, assisting the flow through of franking credits and carried-forward tax losses; and
- the ability of unitholders in the AMIT to adjust their tax cost basis in their units so as to avoid double taxation.
To be eligible as an AMIT:
- a trust must be a MIT (described above);
- the trust deed must clearly define the entitlements of all unitholders to the trust’s income and capital; and
- the trustee must be under an obligation to treat all members of the same class equally and members of different classes fairly.
These eligibility requirements must be met for each income year. Should the requirements not be satisfied, the normal rules relating to the taxation of trusts and MITs will apply.
VCLPs and ESVCLPs
The VCLP regime was introduced to increase foreign investment in the Australian venture capital sector by offering a familiar fund structure (the limited partnership) with tax benefits (see question 17 regarding the tax treatment of VCLPs) in exchange for making investments in Australian businesses that meet certain eligibility criteria.
A VCLP is a separate legal entity and can contract on this basis.
The use of VCLPs has been limited to venture capital and mid-market private equity funds because of the restrictions on the types of investments that VCLPs can make. For example:
- the investment must be ‘at risk’ (meaning there can be no arrangements to maintain the value of the investment or maintain any earnings or other return that might be made from owning the investment);
- the investment must be in shares or options in a company or units in a trust;
- the target must meet several criteria, including without limitation having an Australian nexus; engaging primarily in activities that are not ineligible activities (such as finance and property development); not investing the VCLP’s investment in other entities; having total assets of A$250 million or less; having a registered company auditor and the investment is not listed (in each case, subject to exceptions); and
- the investment must not constitute more than 30 per cent of the VCLP’s committed capital.
VCLPs need a minimum raising of A$10 million from investors to be established and registered and have a life of five to 15 years. There is no maximum size restriction for VCLPs.
The ESVCLP is essentially an extension of the VCLP regime. It was introduced to encourage early-stage venture capital investment by offering further taxation advantages for investors (see question 17 regarding the tax treatment of ESVCLPs) provided the fund only invests in early-stage investments and meets certain other tests - these are similar to the restrictions applying to VCLPs except that the target must not have total assets (including goodwill) of more than A$50 million and there are different restrictions on investing in pre-owned shares and listed entities. Despite these restrictions, the ESVCLP structure has gained popularity with high-net-worth investors who value the tax advantages offered by the ESVCLP and want exposure to early stage venture capital. An ESVCLP’s fund size is capped at A$200 million.
CCIV and LPCIV
The Australian government is currently consulting on a form of a corporate collective investment vehicle referred to as the CCIV and, as at October 2018, has completed the consultation process for the third tranche of the CCIV legislation. Consultation is also expected in the near future on a limited partnership collective investment vehicle. It is not yet known when these structures will be available for use, but they may be attractive vehicles for PE funds.
Forming a private equity fund vehicle
What is the process for forming a private equity fund vehicle in your jurisdiction?
Fund formation is taking a well-trodden path in Australia. The typical process can be broken down as follows:
Fund formation process
Decide fund size
Draft term sheet
Decide on key message
Set up electronic data room
Start developing fund structure
Decide on international strategy (if any)
Tax advisers and any relevant local jurisdiction advisers appointed
Finalise pitch document
Draft private placement memorandum
Find investment committee members
Establish fund vehicles (if relevant)
Draft fund documents
Negotiate fund documents (including side letters)
The timetable can vary greatly depending on the reputation and track record of the manager and the appetite of investors for exposure to the assets being targeted, but generally a four-month period is typical from the establishment phase to first close. A fund established as an ESVCLP must also pass through a substantive registration process with Innovation and Science Australia, where the fund’s investment plan is evaluated against legislative criteria and the policy of supporting early-stage companies, which can also increase the time to first close.
Financial, tax and legal advisers will generally play a very significant role in fund structuring and ensuring compliance with the applicable laws.
The key process revolves around the settling of the fund terms and discussions and negotiations with investors. The fund documentation, while involved and complex, has become reasonably standardised across Australian PE funds for similarly structured funds (although the terms can vary widely from one fund to the next).
Is a private equity fund vehicle formed in your jurisdiction required to maintain locally a custodian or administrator, a registered office, books and records, or a corporate secretary, and how is that requirement typically satisfied?
A private equity fund vehicle formed in Australia could have a domestic or international PE fund manager, although to access the concessional tax treatment afforded by the VCLP, ESVCLP, MIT and AMIT regimes the specific requirements associated with those regimes must be complied with (for example, the MIT regime requires that the trustee of the trust be an Australian resident for tax purposes).
A PE fund manager that carries on a financial services business in Australia will generally be required to hold an AFSL, which will set out the authorised activities that the manager may undertake. The licensed entity will usually be the manager of the fund. For now, many international PE funds that do business in this jurisdiction may be able to take advantage of certain licensing relief where they have only limited ties to Australia or where Australia and their home jurisdiction have specific ‘passporting’ arrangements in place. However, in late 2016, the Australian Securities and Investments Commission (ASIC) simultaneously repealed the passport relief instruments and extended the operation of the relief to September 2018, and then further extended operation to September 2019. During this period, ASIC has been reviewing the framework for passport relief and released a consultation paper in May 2018. At the time of writing, ASIC has proposed to repeal the existing avenues of relief for foreign financial service providers (FFSPs) over a transitional period until 30 September 2020, and introduce a limited AFSL regime for FFSPs.
A domestic fund manager will generally have a head office in Australia, be structured as a proprietary limited company (which requires at least one resident director) and have a company secretary. Apart from the compliance requirements associated with AFSLs, limited financial records and statutory registers are required to be kept.
VCLPs and ESVCLPs are able to hold assets directly, but in the case of trusts (including MITs and AMITs), trustees hold the title and, where they have more than 20 clients, may need an AFSL with a custody authorisation to enable them to do so. Alternatively, a licensed custodian can be hired to provide this service to the fund. Where the trustee has fewer than 20 clients, there are some exemptions from the requirement for a fund manager to either hold an AFSL with an authorisation to provide custody services or use an external custodian.
Access to information
What access to information about a private equity fund formed in your jurisdiction is the public granted by law? How is it accessed? If applicable, what are the consequences of failing to make such information available?
Very little information is available to the public relating to typical PE fund structures in Australia.
Owing to the fact that investors are predominantly institutional or wholesale, there are no registration requirements for the fund or those investors and no disclosure obligations imposed by law relating to funds or fund investments.
If the fund is registered as a VCLP or ESVCLP, the name of the fund is publicly available on a government website; limited information relating to the identity of investors may be requested through a business regulator in this jurisdiction on payment of a fee; and information about investments must be reported to a government regulator to verify compliance with the investment limitations applying to the VCLP or ESVCLP regime (as applicable) (but this investment information is not available through any public forum).
The AFSL laws in Australia require the licensed entity (which, as noted above, will usually be the manager) to have their accounts audited and lodged with ASIC, but these are the accounts of the licence holder (for the purposes of evidencing minimum capital requirements to the extent required under Australian licensing laws).
The specific terms of the AFSL are also publicly available.
Limited liability for third-party investors
In what circumstances would the limited liability of third-party investors in a private equity fund formed in your jurisdiction not be respected as a matter of local law?
In the case of trusts (including MITs and AMITs), it is typical to provide in the trust deed that beneficiaries will not be liable for any amount beyond the amount subscribed to the trust (or which they are legally obliged to subscribe). Whether limitations of that kind are effective (other than in the case of fraud or the like) has yet to be tested before the courts in Australia. There is case law that suggests that the liability of beneficiaries may be excluded by express provision in the trust deed, provided the loss did not arise from a breach of trust committed by the trustee at the request or instigation of the beneficiary in circumstances that would entitle the trustee to hold the interest of that beneficiary as security against personal liability of the trustee for that loss.
Because VCLPs and ESVCLPs are incorporated entities, the limited liability of third-party investors will be respected in the same manner as shareholders in a corporation.
Fund manager’s fiduciary duties
What are the fiduciary duties owed to a private equity fund formed in your jurisdiction and its third-party investors by that fund’s manager (or other similar control party or fiduciary) under the laws of your jurisdiction, and to what extent can those fiduciary duties be modified by agreement of the parties?
Duties of managers, general partners and trustees of private equity funds arise in many respects. There are duties to act in the best interests of members arising at law for the trustee of a trust, enforceable against that trustee. These duties will usually be reinforced through the trust deed establishing the trust.
The general partner of a VCLP or ESVCLP has duties arising under the terms of the partnership deed governing the VCLP or ESVCLP (as applicable), which generally reflect the legal duties of a trustee to act in the best interests of members (or in this case, limited partners).
The AFSL imposes duties on the licensed entity to act efficiently, honestly and fairly, effectively extending duties of a fiduciary nature from the licensed entity to investors.
While the legal fiduciary duties cannot be contracted out of, the terms of the relevant trust deed or partnership deed may amend or modify those duties to provide for terms agreed between the investors and the sponsor.
Does your jurisdiction recognise a ‘gross negligence’ (as opposed to ‘ordinary negligence’) standard of liability applicable to the management of a private equity fund?
Owing to the most recent case law in Australia on the subject, it is generally accepted that there is no legal distinction to be made between the concepts of negligence and gross negligence.
Other special issues or requirements
Are there any other special issues or requirements particular to private equity fund vehicles formed in your jurisdiction? Is conversion or redomiciling to vehicles in your jurisdiction permitted? If so, in converting or redomiciling limited partnerships formed in other jurisdictions into limited partnerships in your jurisdiction, what are the most material terms that typically must be modified?
There are no special issues or requirements under Australian law other than as described in this chapter. Funds raised outside of Australia by Australian fund managers are affected by regulatory changes in other jurisdictions, for example in the US (in particular the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and the Foreign Account Tax Compliance Act (FATCA)) and the EU (in particular the directive on alternative investment fund managers (AIFMD)).
Generally, there is no facility for redomiciling a limited partnership to this jurisdiction.
Fund sponsor bankruptcy or change of control
With respect to institutional sponsors of private equity funds organised in your jurisdiction, what are some of the primary legal and regulatory consequences and other key issues for the private equity fund and its general partner and investment adviser arising out of a bankruptcy, insolvency, change of control, restructuring or similar transaction of the private equity fund’s sponsor?
In an insolvency event, the general partner or trustee and the manager will be required to retire under typical Australian PE fund constituent documents. An insolvency event and change of control or key person of the fund manager will also typically constitute a capital call relief event.
Under the terms of the AFSL, the licensed entity needs to remain solvent and have positive net assets to keep its licence.
Regulation, licensing and registration
Principal regulatory bodies
What are the principal regulatory bodies that would have authority over a private equity fund and its manager in your jurisdiction, and what are the regulators’ audit and inspection rights and managers’ regulatory reporting requirements to investors or regulators?
ASIC is the principal regulatory authority that has oversight of the operation of PE funds in this jurisdiction. Through the AFSL licensing regime, licensed entities are required to prepare and publicly lodge audited accounts and comply with stringent ASIC requirements relating to compliance and compliance auditing. ASIC has the right at any time to inspect books and records of a licensed entity in relation to their compliance with these provisions of the Corporations Act.
Innovation and Science Australia is the government agency responsible for registering incorporated limited partnerships as ESVCLPs or VCLPs (as applicable).
What are the governmental approval, licensing or registration requirements applicable to a private equity fund in your jurisdiction? Does it make a difference whether there are significant investment activities in your jurisdiction?
Most private equity funds target predominantly institutional or wholesale investors, meaning there are no registration requirements for the fund per se under the corporations legislation. If a private equity fund were to target retail investors, however, the Australian regulations would require the fund to be registered and the constituent documents to comply with strict requirements.
VCLPs and ESVCLPs established in Australia must be registered as an incorporated limited partnership in a particular state and as a VCLP or ESVCLP with the federal government body that oversees the VCLP and ESVCLP regimes.
The trustee of a MIT must elect for the trust to be treated as a MIT and, similarly, the trustee of an AMIT must elect for the trust to be treated as an AMIT (although this latter election can be evidenced in the way in which the tax return for the AMIT is prepared).
Otherwise, the AFSL requirements described in this chapter are the chief licensing requirements applicable to fund managers.
In some circumstances, a foreign investor may require approval to invest into an Australian-domiciled private equity fund under Australia’s foreign investment laws.
Registration of investment adviser
Is a private equity fund’s manager, or any of its officers, directors or control persons, required to register as an investment adviser in your jurisdiction?
The AFSL registration requirements as described in this chapter need to be satisfied.
Fund manager requirements
Are there any specific qualifications or other requirements imposed on a private equity fund’s manager, or any of its officers, directors or control persons, in your jurisdiction?
Under the terms of the AFSL, the entity managing the fund must have organisational capacity and relevant experience with dealing in and advising on securities to wholesale clients at a minimum. These requirements set out detailed tests that need to be satisfied by the persons responsible for the day-to-day management and operation of the PE fund.
Describe any rules - or policies of public pension plans or other governmental entities - in your jurisdiction that restrict, or require disclosure of, political contributions by a private equity fund’s manager or investment adviser or their employees.
In terms of political donations, the PE industry is not regulated as a separate industry. The Commonwealth Electoral Act 1918 (Electoral Act) implements a disclosure scheme that requires candidates, registered political parties, donors and other political actors to lodge annual or election period financial disclosure returns with the Australian Electoral Commission. This scheme requires the disclosure of certain information, including among other things any individuals who made a donation above the legislative threshold, which is currently A$13,800 (indexed annually).
The new Electoral Legislation Amendment (Electoral Funding and Disclosure Reform) Act 2018 amends the Electoral Act and is a significant change to Australia’s existing landscape of political funding and disclosure rules. Among other things, the reforms significantly restrict receipts from foreign donors.
Many Australian superannuation funds - which are significant investors in Australian PE - require fund managers to adopt governance rules in relation to various matters, including political donations. This varies from one fund to the next.
Use of intermediaries and lobbyist registration
Describe any rules - or policies of public pension plans or other governmental entities - in your jurisdiction that restrict, or require disclosure by a private equity fund’s manager or investment adviser of, the engagement of placement agents, lobbyists or other intermediaries in the marketing of the fund to public pension plans and other governmental entities. Describe any rules that require a fund’s investment adviser or its employees and agents to register as lobbyists in the marketing of the fund to public pension plans and governmental entities.
There are no rules that relate specifically to a PE fund manager’s marketing of a fund to public pension plans or government entities.
Describe any legal or regulatory developments emerging from the recent global financial crisis that specifically affect banks with respect to investing in or sponsoring private equity funds.
There are no Australian rules that specifically affect banks with respect to investing in or sponsoring private equity funds.
Would a private equity fund vehicle formed in your jurisdiction be subject to taxation there with respect to its income or gains? Would the fund be required to withhold taxes with respect to distributions to investors? Please describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.
The typical private equity fund structures referred to above are generally flow-through vehicles, in that the income and profits of the fund structure are generally taxed in the hands of the investor (however, see comments below regarding MIT withholding tax (MITWHT) and withholding tax on dividends and interest paid to non-residents).
Many fund structures use combinations of the different structures and a combination of the Australian tax considerations outlined below may therefore apply.
Subject to the special rules described below, gains made by private equity funds are generally treated as being of an income character (as opposed to being of a capital character) unless it can be established that the particular fund intended to derive income in the form of regular returns during the period of holding (rather than merely gains on disposal).
Unitholders in a trust are generally taxed on their share of the taxable income of the trust determined using the proportion of the accounting income of the trust to which they are presently entitled. The trustee of the trust is required to pay tax on income to which a non-resident unitholder is presently entitled, but that unitholder gets a credit for the tax paid by the trustee and can obtain a refund of the trustee tax if it is excessive in the circumstances.
Withholding tax will apply to distributions to non-resident unitholders that derive from unfranked dividends and royalties (generally 30 per cent) and interest (generally 10 per cent). The applicable withholding tax rate may be reduced under an applicable double tax agreement (DTA).
Where a trust carries on an active business or controls a company that carries on an active business, the trust can itself be treated as a company in some circumstances. The Australian Taxation Office (ATO) has taken an initial view that a power to veto could amount to control for these purposes. As this outcome is contrary to a principal objective of using a trust, these rules should be carefully considered and applied.
Losses made by a trust are quarantined within the trust and do not flow to unitholders. The losses may be used by the trust in future years provided various trust loss rules are satisfied.
A trust that is a MIT is able to make an election to deem certain gains made by the MIT to be on capital account (rather than the default revenue character described above). This means that Australian investors may be able to access concessional tax rates for capital gains and non-resident investors will generally not have any Australian income tax liability unless the relevant capital gain made by the MIT is in relation to taxable Australian property (eg, interests in land and non-portfolio interests in land-rich entities) or the non-resident investor has a permanent establishment in Australia.
Subject to meeting certain additional requirements, distributions to non-residents by a MIT of certain taxable amounts may qualify for MITWHT at a 15 per cent rate (depending on the nature of the income distributed and the tax residence of the investor). However, where the investor is a resident of a country other than an ‘information exchange country’ (as defined by income tax regulations), the applicable rate of MITWHT is 30 per cent. Additionally, legislation is expected to be enacted with effect from 1 July 2019 (subject to transitional rules) such that ‘non-concessional MIT income’ will also be subject to a MITWHT rate of 30 per cent. Non-concessional MIT income broadly includes trading income that is converted to passive income via a stapled structure, rent derived from Australian agricultural land and rent derived from residential premises. A 10 per cent rate may be available for eligible distributions by MITs that hold only certain energy-efficient buildings constructed from 1 July 2012.
This withholding tax will apply to various distributions, including distributions of taxable capital gains (namely, capital gains derived in relation to taxable Australian property) and income that has an Australian source (such as rental income in relation to land situated in Australia).
Because Australian-resident investors are taxed by assessment, a MIT does not generally need to withhold from amounts paid to Australian resident investors.
Whereas the unitholders in a trust are generally taxed on a proportionate basis on the income of the trust, the AMIT regime allows for income of a particular character to be attributed to particular unitholders in accordance with their ‘clearly defined rights to income and capital’ in the trust deed. The rules also allow for various other benefits, such as dealing with unders and overs in the income year in which they are discovered, deeming of the AMIT to be a fixed trust (which assists with the flow through of franking credits and carried-forward tax losses) and the making of adjustments to the cost base of units to avoid double taxation for unitholders.
Where a VCLP is used as the fund vehicle, subject to certain exceptions, both income and losses are attributed to investors. Australian investors will need to include the relevant partnership profit in their assessable income or claim the corresponding deduction for any loss. Subject to an exception that applies to certain superannuation investor entities and unlike MITs, the gains made by a VCLP are not deemed to be made on capital account, and so such gains may be made on revenue account (and not be concessionally taxed as capital gains).
Certain non-resident investors (such as tax-exempt foreign residents, foreign venture capital fund of funds with no more than 30 per cent of the VCLP’s committed capital and other foreign investors with less than 10 per cent of the VCLP’s committed capital) are given a specific exemption from Australian income tax on gains made in relation to investments held by the VCLP. If a non-resident investor does not satisfy the exemption criteria, it may have an Australian income tax liability in relation to gains made by the VCLP.
There is no withholding tax on distributions of gains on investments made by a VCLP to non-residents.
Unfranked dividends or interest derived by the VCLP and paid to a non-resident investor are subject to withholding (generally 30 per cent in the case of an unfranked dividend or generally 10 per cent in the case of interest (subject to the operation of any applicable DTA)).
Because Australian resident investors are taxed by assessment, generally no amount needs to be withheld from amounts paid to them.
Where an ESVCLP is used as the fund vehicle, subject to certain exceptions, both Australian investors and foreign investors may be entitled to tax-free returns from the ESVCLP.
Key tax features of the ESVCLP regime for investors include the following:
- a non-refundable offset of up to 10 per cent of a limited partner’s contributions to an ESVCLP that is unconditionally registered;
- a limited partner’s share of any gain or profit from the disposal or realisation of an eligible venture capital investment by the ESVCLP is exempt from Australian income tax, if the partnership owned the investment for at least 12 months; and
- a limited partner’s share of income derived from an eligible venture capital investment (for example, dividends paid by an investee) held by the partnership is exempt from Australian income tax. Unfranked dividends or interest derived by the ESVCLP and paid to a non-resident investor are subject to withholding (generally 30 per cent in the case of an unfranked dividend or generally 10 per cent in the case of interest (subject to the operation of any applicable DTA)).
Losses made by an ESVCLP are typically not deductible to investors.
Local taxation of non-resident investors
Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?
A foreign investor in a MIT (which has made a capital account election) will generally not, in relation to gains made by the MIT, have to pay any Australian income tax and will not have any income tax filing obligations if the fund does not hold taxable Australian property and the non-resident investor does not have a permanent establishment in Australia. As noted above, the trust may have a MITWHT or dividend or interest withholding tax obligation on certain payments made to the non-resident, but these are final taxes that do not require the non-resident to lodge a tax return.
Where a VCLP or ESVCLP derives a gain on the disposal of investments, the non-resident investor will generally not have any Australian income tax and income tax-filing obligations where the foreign investor falls within the relevant exemption categories under the VCLP or ESVCLP rules (as applicable) (for example, where the foreign investor holds less than 10 per cent of the VCLP’s committed capital). Otherwise, they will need to consider whether they have a liability to Australian income tax and tax filing requirements if the gain is not on capital account. As noted above, dividend or interest withholding tax obligations may exist in relation to certain payments made to the non-resident, but these are final taxes that do not require the non-resident to lodge a tax return.
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 12.5 per cent of the proceeds from the sale. It should be noted that not only does this withholding apply to the taxation of capital gains, it also applies 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 vendor’s Australian income tax return.
Local tax authority ruling
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a private equity fund vehicle formed in your jurisdiction? Are there any special tax rules relating to investors that are residents of your jurisdiction?
Taxation rulings are typically not sought on the fund structure (however, there are exceptions, particularly in relation to ensuring MIT or AMIT status or in relation to sovereign investors). Relevant differences in the income tax treatment between resident and non-resident investors have been highlighted above. In some situations, it may be preferable to obtain an advance ruling on the extent to which gains of a fund are protected by treaties based on the residence of the ultimate investors, especially where other concessions discussed above are not applicable.
Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?
No significant organisational income taxes are generally payable except as discussed above.
Special tax considerations
Please describe briefly what special tax considerations, if any, apply with respect to a private equity fund’s sponsor.
Carried interests in MITs are specifically deemed to be on income account by the tax law and will not be concessionally taxed as capital gains. On the other hand, carried interests of a general partner in VCLPs and ESVCLPs are deemed to be on capital account and are concessionally taxed as capital gains.
Please list any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.
Australia has comprehensive DTAs with Argentina, Austria, Belgium, Canada, Chile, China, the Czech Republic, Denmark, Fiji, Finland, France, Germany, Greece, Hungary, India, Indonesia, Ireland, Italy, Japan, Kiribati, Korea, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Norway, Papua New Guinea, the Philippines, Poland, Romania, Russia, Singapore, Slovakia, South Africa, Spain, Sri Lanka, Sweden, Switzerland, Taiwan, Thailand, Turkey, the United Kingdom, the United States and Vietnam. These largely follow the OECD approach to the allocation of taxing rights.
The interaction between Australia’s DTAs and the taxation of partnerships and trusts is complex. However, we make the following general observations:
- withholding tax rates on distributions of interest and dividends to non-resident investors in a MIT or VCLP have been considered briefly above (the rate of withholding on interest, royalties and dividends may be reduced by the terms of the relevant DTA); and
- in relation to gains made by a MIT or VCLP, this interaction should largely be irrelevant (from an Australian income tax perspective) where the MIT does not make any gains on taxable Australian property (and the relevant foreign investor does not have a permanent establishment in Australia) or where the foreign investor in the VCLP falls within one of the exemption categories noted previously.
In addition, the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) will enter into force for Australia on 1 January 2019. The MLI will modify Australia’s applicable bilateral tax treaties to implement measures designed to address multinational tax avoidance.
Other significant tax issues
Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?
There is increasing sensitivity to the use, by investors, of entities located in tax havens, the requirement for interposed entities to have substance and on the risk profile of related party financing arrangements. The issue of control of active businesses is also an issue that has come under recent scrutiny, particularly where fund structures convey ‘negative control’.
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.
Where an investment by a foreign person is subject to Australia’s foreign investment laws, it is not unusual to have tax conditions imposed on the investment 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.
A case regarding the characterisation of foreign limited partnerships for Australian income tax purposes was recently litigated by the Commissioner of Taxation. In a decision that generally surprised industry, the Federal Court ruled that the relevant limited partnerships was not a ‘taxable entity’. The decision ran counter to generally accepted tax law positions. The Commissioner of Taxation appealed the Federal Court’s decision and the appeal was heard by the Full Federal Court on 9 and 10 August 2018. The court had not issued its judgment at the time of writing.
Selling restrictions and investors generally
Legal and regulatory restrictions
Describe the principal legal and regulatory restrictions on offers and sales of interests in private equity funds formed in your jurisdiction, including the type of investors to whom such funds (or private equity funds formed in other jurisdictions) may be offered without registration under applicable securities laws in your jurisdiction.
In Australia, wholesale investors (persons investing more than A$500,000 or persons who can demonstrate that they exceed a particular threshold of assets or income) and institutional and professional investors are the investors typically targeted by PE funds. Australian law does not require disclosure to these parties for issues of interests in PE funds.
If any offers of interests are made in a PE fund (domestic or international) to Australian investors who are retail persons (not wholesale), the fund manager will need to be comfortable that an exemption to the disclosure requirements applies. Otherwise a prospectus or product disclosure statement will need to be issued and registered with ASIC.
If issues of interests in the PE fund are to retail persons, the fund will also need to be registered and additional licensing (and financial) requirements will apply to the fund manager.
Types of investor
Describe any restrictions on the types of investors that may participate in private equity funds formed in your jurisdiction (other than those imposed by applicable securities laws described above).
There are no restrictions on the types of investors that may participate in PE funds; however, the nature (retail versus wholesale) and identity of the investors will have implications for the compliance obligations imposed by the Corporations Act and the tax treatment likely to be afforded to the PE fund (ie, whether the investors will be entitled to rely on a relevant DTA).
Identity of investors
Does your jurisdiction require any ongoing filings with, or notifications to, regulators regarding the identity of investors in private equity funds (including by virtue of transfers of fund interests) or regarding the change in the composition of ownership, management or control of the fund or the manager?
For VCLPs, ESVCLPs and MITs the number and mix of investors will be relevant for ongoing registration and eligibility requirements and in the case of VCLPs and ESVCLPs needs to be notified to certain government agencies. The change of control of a financial services licensee needs to be notified to ASIC, so this would apply to fund managers.
Licences and registrations
Does your jurisdiction require that the person offering interests in a private equity fund have any licences or registrations?
An AFSL needs to be held on the basis described above. In addition, elections need to be made by the fund manager to obtain MIT or AMIT status, and the VCLP or ESVCLP needs to be registered with the relevant state as an incorporated limited partnership and as a VCLP or ESVCLP with the relevant federal government regulator in order to enjoy the tax benefits afforded to those vehicles.
Describe any money laundering rules or other regulations applicable in your jurisdiction requiring due diligence, record keeping or disclosure of the identities of (or other related information about) the investors in a private equity fund or the individual members of the sponsor.
By issuing interests in a fund, a private equity fund is providing a designated service under Australian Anti-Money Laundering and Counter-Terrorism Financing legislation (AML/CTF) and must comply with AML/CTF as a reporting entity.
As a reporting entity, the fund is subject to the following obligations:
- enrolling with the regulator (AUSTRAC);
- conducting investor identification and verification and ongoing investor due diligence, including transaction monitoring;
- reporting suspicious matters to AUSTRAC within 24 hours or three business days, as required;
- reporting transactions greater than A$10,000 to AUSTRAC within 10 business days;
- providing compliance reports to AUSTRAC;
- implementing and complying with an AML/CTF programme that includes the designation of an AML/CTF compliance officer, systems for identifying, mitigating and managing risks, employee risk awareness training and due diligence programmes, transaction monitoring, independent review of the AML/CTF programme and investor identification and verification procedures; and
- retaining records relating to investors and retaining each AML/CTF programme in force for a period of seven years after the record ceases to be in force.
The reporting entity is required to collect and verify information regarding the identity of the fund’s investors and sponsor’s members, and may be required to disclose this information when reporting certain matters to AUSTRAC (eg, when enrolling with AUSTRAC or reporting funds transfer instructions).
Are private equity funds able to list on a securities exchange in your jurisdiction and, if so, is this customary? What are the principal initial and ongoing requirements for listing? What are the advantages and disadvantages of a listing?
While there are some examples of listed private equity fund of funds on the Australian Securities Exchange investing in PE assets through fund managers, and many listed companies and funds will have exposure to PE asset allocations, the traditional PE model in Australia has not involved listed funds. There has also been no large sponsor in this jurisdiction to give retail clients exposure to Australian PE funds.
Most Australian PE funds have wholesale or institutional clients only, and although some have a small retail client base, the run to listing has not been evident here.
Restriction on transfers of interest
To what extent can a listed fund restrict transfers of its interests?
A listed fund cannot restrict the transfer of its interests; however, the Corporations Act provides restrictions on the ability of a person to acquire a relevant interest (tantamount to control of the relevant shares or units) in more than 20 per cent of the voting securities in the listed entity. The Foreign Investment Review Board may also restrict foreign persons from acquiring 20 per cent or more of certain Australian businesses meeting a range of value thresholds, including listed funds. Foreign government investors will generally also need to seek approval for any ‘direct investment’ (which includes most investments of 10 per cent or more, and investments below 10 per cent that have special features evidencing a strategic long-term investment).
Participation in private equity transactions
Legal and regulatory restrictions
Are funds formed in your jurisdiction subject to any legal or regulatory restrictions that affect their participation in private equity transactions or otherwise affect the structuring of private equity transactions completed inside or outside your jurisdiction?
There are some restrictions that apply, such as the size restrictions on the assets that can be acquired by a VCLP or ESVCLP, a cap on the percentage of committed capital that can be invested in an entity by a VCLP or ESVCLP, and the control issues described above in relation to trusts (see question 17), but generally a PE fund has an entitlement to invest on the same basis as any other investor. Of course, each private equity fund may itself regulate the size and nature of transactions to be undertaken on its behalf. Further, owing to their investor base, many PE funds are deemed to be ‘foreign government investors’ for purposes of Australia’s foreign investment rules. This will require such funds to obtain foreign investment approvals for most investments in Australia.
Compensation and profit-sharing
Describe any legal or regulatory issues that would affect the structuring of the sponsor’s compensation and profit-sharing arrangements with respect to the fund and, specifically, anything that could affect the sponsor’s ability to take management fees, transaction fees and a carried interest (or other form of profit share) from the fund.
The ability to draw management fees and performance fees from a typical PE fund in Australia is subject only to the terms of the fund documents and the negotiations with investors, and also market practice. Separate carry trusts are also commonly used to stream carry to management.
Update and trends
Updates and trends
The ESVCLP and VCLP regimes have undergone additional tinkering, particularly in relation to the question of whether fintech businesses constitute eligible investments for funds structured as ESVCLPs or VCLPs. As noted in question 1, ESVCLPs and VCLPs must invest in businesses that predominantly carry on activities that are not ineligible (ineligible activities include finance), and this is an ongoing requirement (ie, it is not limited to the circumstances at the time the investment is made). The new rules significantly muddy the waters for investments in fintech businesses, as they suggest that as a fintech business develops it may become ineligible (and therefore have to be divested), but there is no clear test to determine where that point is.
Foreign investment issues continue to plague PE funds, many of which are deemed to be foreign government investors due to investment by sovereign wealth funds and public sector pension funds. This means virtually every investment by a PE fund in Australia requires foreign investment approval, regardless of value. A new exemption certificate regime that was designed to alleviate this issue has not proven to be as workable as had originally been hoped.