The Australian Taxation Office (“ATO”) released two documents of particular importance to infrastructure participants on 31 January 2017.
The first, Taxpayer Alert TA 2017/1 (the “Alert”), sets out the ATO’s concerns with a variety of arrangements it has seen being used (often stapled trust and company structures) that it considers fragment an integrated trading business into separate businesses to achieve a more favourable tax outcome for investors.
The second document is an updated draft of the ATO’s “Privatisation and Infrastructure – Australian Federal Tax Framework” (the “Draft Framework”) which substantially builds upon the draft framework that was released in 2015. This document sets out the ATO’s position on a range of infrastructure-related tax issues and highlights both how the ATO would expect the law to apply to a number of common issues as well as areas of concern that they have in the privatisation context.
The Alert provides a high-level summary of the concerns that the ATO have with certain arrangements involving the “fragmentation” of integrated trading businesses in a contrived way into separate businesses (i.e., to separate a business into a trust (Asset Trust) and a company or corporate tax entity (Operating Entity)). Whilst the Alert is particularly focussed on stapled structures it is not limited to such arrangements.
The key concern the ATO has with such arrangements is the “recharacterisation” of trading income into passive income, thereby potentially achieving a lower rate of effect tax for some taxpayers (particularly for non-residents via the managed investment trust (“MIT”) regime).
The Alert identifies 4 arrangements where the ATO has seen this division of a single business occur (using stapled structures), which broadly involve:
- Finance Staple: the lending of trust equity by the Asset Trust to the Operating Entity at interest. Operating Entity claims a tax deduction for payments to Asset Trust.
- Synthetic Equity Staple: a synthetic equity arrangement that involves the Operating Entity paying turnover equivalent / profit equivalent amounts to the Asset Trust. The Operating Entity claims a tax deduction for payments to Asset Trust.
- Royalty Staple: The Operating Trust pays a royalty / purported royalty to the Asset Trust, who then makes distributions to its non-resident investors subject to royalty withholding tax. The Operating Entity claims a tax deduction for payments to the Asset Trust.
- Rental Staple: The Asset Trust owns land / fixtures, which are leased to the Operating Entity to enable it to operate its business. The Operating Entity claims a tax deduction for payments to Asset Trust.
The ATO identify a number of “technical” or “substantive” tax concerns that they have with respect to each of the above arrangements but note that even if the structures are otherwise effective they might attract the operation of the general anti-avoidance provision Part IVA. Unfortunately the analysis that has been provided is broad, and high-level in nature. Whilst the ATO have noted that as their position evolves, further guidance will be released, the Alert does not provide any timeframe for this.
Importantly, there are some notable exceptions to the application of the Alert:
- Australian real estate investment trusts which derive all or most of their rental income from unrelated third party tenants and which have not entered into any of the arrangements discussed in the Alert; and
- Privatisations of businesses which are effectively land (and land improvements) (refer below to our discussion on the Draft Framework, where the ATO has provided certain guidance in relation to arrangements the subject of this exception).
Additionally the ATO acknowledge that there are certain businesses operated through stapled structures whereby the Asset Trust leases buildings of a traditional real estate nature to the Operating Trust, to make available to independent end-users albeit not in the form of a lease. In circumstances where this is a common observable market or practice exists in that industry for such arrangements, the ATO encourages such taxpayers to engage with them as in such cases, their concern is that the Operating Entity retains a sufficient share of the profits (rather than a concern in relation to the stapled structure itself).
ATO advice to taxpayers
As noted above, further guidance will be released by the ATO – both in relation to the specific concerns identified in the Alert and for particular industries. In the meantime, the ATO is “discouraging“ taxpayers from entering into arrangements of the types identified above and requests that taxpayers that have or are considering similar arrangements to discuss their situation with them.
The concern for taxpayers in this position is the uncertainty that they are subjected to particularly given the lack of detailed analysis in the Alert together with the nature of the Alert itself. Alerts provide a summary of the ATO’s concerns in relation to new or emerging higher risk tax arrangements or issues that the ATO has under risk assessment. There are not a public ruling, and are published under the Commissioner’s general powers of administration.
The Draft Framework
The Draft Framework sets out the ATO’s overall position on a range of infrastructure-related tax issues, particularly in the context of privatisations.
Broadly, the document provides further details on:
1. The construction of social infrastructure using the “securitised licence” PPP model, including analysis of how the income tax and GST laws would apply to a “social” PPP.
2. The privatisation of Government businesses into stapled structures, including an analysis of how the income tax and GST laws would be expected to apply. It also provides details of the types of privatisations and structures that should be used by taxpayers in order for taxpayers to rely upon the exception for privatisations referenced in the Alert.
3. In particular, the Draft Framework confirms that the ATO will not apply compliance resources in circumstances where the privatisation of a Government business into a stapled structure involves:
a. The Government business being privatised is land rich;
b. The granting by the Government to a consortium of a long term lease of the Government businesses’ land assets, and the consortium agreeing to pay a lease premium in return for the grant;
c. The disposal of the “non-land assets” including intangibles such as licences to operate the business to the consortium for consideration;
d. The consortium using the assets acquired to run the privatised Government business for the period of the lease; and
e. In some cases, the consortium agreeing to operate, maintain and sometimes upgrade or expand the assets of the business over the term of the lease;
4. Other infrastructure-related issues (for example, government grants, customer cash contributions / reimbursements, gifted assets, capitalised labour, underground power lines and control for the purposes of Division 6C); and
5. Certain infrastructure structure related issues with which the ATO has concerns, which include:
a. what it considers to be some “abuses” of PPP structures including the adoption of “securitisation structures” to recharacterise income from trading businesses (which they note is in addition to its concerns on stapled structures set out in the Alert);
b. illegitimate uses of stapled structures (which is effectively stapled structures of the type not specifically addressed in the Draft Framework;
c. fracturing of control interests to facilitate what the ATO calls “double gearing structures” (which allow debt deductions at both the entity and investor levels as well as ensuring access to the MIT concessions;
d. satisfaction of MIT requirements; and
e. the availability of the section 128F exemption in circumstances where lenders may be associated with the project borrowing vehicle (which can potentially arise where foreign state owned enterprises are investors), allocation of purchase price across stapled entities and even in relation to some of the technical requirements to being a MIT (such as having more than one unitholder in order to be a managed investment scheme).
At this stage, the Draft Framework is intended to generate feedback form stakeholders on the issues raised in relation to the taxation of income for privatisation and infrastructure activity. Whilst it does provide more colour around a number of the technical issues raised in the Alert as well as other issues that the ATO has identified in its involvement with recent privatisations, despite its length, there is little analysis provided around some of the issues raised. Furthermore, the ATO seems to be continuing with its position on some key issues including the circumstances in which negative control will amount to control for the purposes of particular provisions of the tax law.
Where does this leave taxpayers?
As infrastructure is obviously an area of great focus of the ATO at present, taxpayers who have implemented or who are currently implementing arrangements of the types addressed will need to carefully consider their positioning to this Alert and the Draft Framework having regard to their specific facts and circumstances. In particular they may wish to consider any benefits of early engagement with the ATO. Taxpayers are also clearly on notice that the issues identified by the ATO in both documents will be the subject to increased ATO review. For non-residents, such review and risk assessment may be expected to form part of the FIRB application process.
Although the ATO will continue to develop its positions set out in the papers it is worth noting that a number of the technical issues raised by the ATO in both the Alert and the Draft Framework are ones which there are acknowledged arguments on both sides. Furthermore the application of the anti-avoidance provisions will ultimately come down to the particular circumstances of an arrangement.
Agencies procuring or dealing with the private sector should be aware of the implications in the event that there is any change required to private sector structuring or contracting methodologies as a result.