Q&A: tax issues for private equity funds in Australia

Taxation

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? Describe what conditions, if any, apply to a private equity fund to qualify for applicable tax exemptions.

Generally, PE funds are flow-through vehicles, meaning that the income and profits from the fund are taxed at the hands of the investor. Gains from PE funds are generally treated as income rather than capital, unless it can be shown that the particular fund intended to derive income in the form of regular returns during the holding period. However, this is not always the case, such as with MITs. There are a number of special considerations that may apply.

Trusts are not separate legal persons, and are not generally treated as separate taxable entities (other than certain public unit trusts that are taxed like companies).

Generally, the beneficiaries of a trust are taxed on a share of the net income of the trust corresponding to the share of the trust income to which the beneficiary is presently entitled. For these purposes, the net income of the trust is, broadly, the taxable income of the trust calculated as if the trust were a resident taxpayer.

Foreign-resident beneficiaries are subject to tax on their share of the net income of the trust estate that is attributable to sources in Australia, at the marginal rates applicable to foreign residents. However, if the income consists of interest, dividends or royalties, tax is not imposed at marginal rates but is imposed on the distribution at withholding tax rates. Foreign residents may be able to rely on a double tax agreement to reduce the incidence of Australian taxation from the foreign resident’s Australian investments.

Tax losses of the trust are not transferable to the beneficiaries Instead, trusts can carry forward losses if they satisfy certain loss recoupment tests. Under the current law, the carry forward of capital losses is not subject to the loss recoupment tests.

Managed investment trusts (MITs) offer significant tax concessions compared with investments in Australian companies and non-MIT trusts. Certain MITs may make an election to treat its assets on capital account for Australian tax purposes, rather than income or revenue, enabling eligible Australian residents to access the capital gains tax discount of up to 50 per cent on capital gain distributions. Additionally, foreign residents will not usually have any Australian income tax liability unless the relevant capital gain made by the MIT is in relation to taxable Australian property or they have a permanent establishment in Australia.

An attribution regime applies to MITs that are qualifying attribution MITs (AMITs). One of the key features of this regime is that investors in the AMIT are taxed on the amounts attributed to them from the AMIT, rather than on their share of the income of the AMIT to which they are currently entitled.

On the other hand, limited partnerships (venture capital limited partnerships (VCLPs) and early stage venture capital limited partnerships (ESVCLPs)) are generally treated as companies for Australian tax purposes and do not have the same advantages as MITs. However, certain hybrid entities and Australian VCLPs may be treated as partnerships for Australian tax purposes where certain conditions are met.

Would non-resident investors in a private equity fund be subject to taxation or return-filing requirements in your jurisdiction?

A foreign resident investor is taxable on all dividends, interest, royalties and fund payments from managed investment trusts, which are subject to withholding tax at the applicable tax rates.

However, foreign investors will generally not have to pay any Australian income tax or file a tax return in relation to capital gains from an MIT if the fund does not hold taxable Australian property and the non-resident investor does not have a permanent establishment in Australia, as explained above.

Trustees of MITs are required to withhold amounts on any distributions that comprise a fund payment made to foreign resident unit holders at either a 10, 15 of 30 per cent rate. For certain MITs (Withholding MITs), foreign residents of information exchange countries (broadly, countries with which Australia has signed a comprehensive exchange of information agreement on tax matters as specified in the tax regulations) can access a reduced rate of withholding tax on fund payments of 15 per cent (instead of the normal 30 per cent rate that applies to residents of other countries), which is further reduced to 10 per cent if the MIT only holds newly constructed energy efficient commercial buildings (or the equivalent standard in relation or residential properties).

For an MIT to qualify as a Withholding MIT, the following must be satisfied:

• the MIT must conduct passive (other than active business) activities;
• licensing requirements in some circumstances; and
• a widely held and ‘not closely held’ test.

Fund payments generally consist of distributions from Australian sourced income (other than interest, dividends and royalties that are subject to a separate withholding tax regime) and capital gains in respect of taxable Australian property.

MIT withholding tax operates as a final tax and foreign resident investors in receipt of distribution to which the withholding tax applies are not required to file an Australian tax return disclosing those distributions.

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?

It generally is not necessary to obtain a ruling from local tax authorities with respect to the tax treatment of a particular structure of a PE fund formed in Australia.

Must any significant organisational taxes be paid with respect to private equity funds organised in your jurisdiction?

There are no significant organisational taxes that need to be paid with respect to PE funds organised in Australia.

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.

List any relevant tax treaties to which your jurisdiction is a party and how such treaties apply to the fund vehicle.

Australia has double tax agreements (DTAs) with Argentina, Austria, Belgium, Canada, Chile, China, Czech Republic, Denmark, Fiji, Finland, France, Germany, Greece, Hungary, India, Indonesia, Ireland, Israel, Italy, Japan, Kiribati, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Norway, Papua New Guinea, the Philippines, Poland, Romania, Russia, Singapore, Slovakia, South Africa, South Korea, 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.

If the foreign resident is resident in a country with which Australia has a DTA, the foreign resident is generally taxable on business income only if it carries on a business in Australia through a permanent establishment to which that business income is attributable.

Notwithstanding the above, certain types of income (eg, dividends, interest and royalties paid by Australian residents and gains from the disposal of Australian land based assets) may be taxed in Australia irrespective of whether the income has an Australian source or (in the case of a treaty country foreign resident investor) if the foreign resident investor has a permanent establishment in Australia.

Are there any other significant tax issues relating to private equity funds organised in your jurisdiction?

In the past several years, the Australian Tax Office (ATO) has increased scrutiny of PE fund investments into Australia.

In particular, after the Texas Pacific Group (TPG Capital) disposed of its shares in Myer by IPO in 2009, the ATO sought to pursue TPG Capital for Australian taxes, including seeking court orders to freeze TPG Capital’s Australian assets on the basis that TPG Capital had not complied with its Australian tax obligations in relation to the sale of Myer.

The ATO has released a number of tax determinations setting out the ATO’s views on various Australian taxation implications for PE funds investing into Australian businesses. Generally, these determinations focus on Australia’s right to tax the profit on the basis of asserting that the profits are ordinary income (and are not capital gains) that have an Australian source and the application of anti-avoidance provisions against treaty shopping. Where a PE fund is able to identify its underlying investors, one of the determinations allows treaty benefits of the investor to be claimed by the PE fund.

Foreign investors should be cognisant of these developments and the recent tax determinations when making investments in Australia.