Stapled property groups need to look closely at their cross staple arrangements or risk raising the ire of the ATO. Taxpayer Alert TA 2017/1 outlines the ATO’s concerns regarding arrangements which attempt to use a trust (Asset Trust) to strip out passive income from an integrated trading business conducted by an operating entity (Operating Entity) which is (or is taxed as) a company, primarily using stapled structures.
The focus is on circumstances where:
- an operating entity obtains a deduction for payments to an Asset Trust;
- the Asset Trust in turn distributes its profits to investors who are taxed on a flow-through basis at concessional tax rates (for example, at withholding tax rates of less than 30%); and
- though the operating entity will likely be taxed at the corporate tax rate, it does not have a significant amount of taxable income, largely because of deductions in respect of the payments to the Asset Trust.
The ATO has outlined a number of structures that it considers do not (or should not) generate income that qualifies for the lower rates of tax potentially applicable to passive investment income.
In doing so, the ATO outlines various approaches that it may seek to apply to eliminate the tax benefit generated by such structures, including Division 6C and Part IVA (in addition to say the debt/equity rules where the ATO has previously raised the potential operation of the existing section 974-80 and subsection 974-70(2)). This brief considers the impact of this taxpayer alert on trusts utilised in infrastructure investments.
TA 2017/1 does not address passive income derived directly by shareholders of the operating company, but only addresses passive income derived via a trust.
Overall relevance to infrastructure participants
Large infrastructure businesses often utilise a trust which holds property (and/or provides finance) to an operating company or trust (where an operating trust may be taxed as a company in any event if it is a public unit trust as defined).
Importantly for infrastructure privatisations, TA 2017/1 specifically carves out privatisations which are effectively land (and land improvement) based, or heavily reliant on particular land holdings and related improvements. The ATO notes that privatisations of these businesses raise distinct issues and that separate general guidance in relation to these transactions/structures will be provided.
The ATO’s draft Infrastructure Framework, which has been released concurrently with TA 2017/1, provides further guidance in relation to privatisations. The ATO typically engages on a transaction by transaction basis for large scale privatisations in any event (Taxpayer Alerts are generally intended to target transactions where the ATO is not engaged on a transaction by transaction basis).
Another apparent carve-out is where there is a common observable market, or a practice already exists in that industry, for an entity similar to an Asset Trust to lease buildings (and presumably land more generally) to unrelated third parties to carry on the same type of business as the Operating Entity carries on. Whilst this carve-out would be helpful in the property industry where say an apartment building or hotel is leased to an operator who conducts a short term traveller accommodation business, it is unlikely to be relevant for infrastructure assets.
Structures that concern the ATO
The primary area in which trusts in the infrastructure space could be affected by TA 2017/1 is so-called rental staples (which need not technically be stapled, for example if there is only one investor, or if there is an Investors Deed where there is a small number of investors). These are structures where the business of the Asset Trust consists principally of a lease of real property to an operating company (and may also include loaning amounts to the operating company).
In these structures, the ATO is concerned that the nature of the business is such that transactions to divide the business in this manner are not transactions that third parties acting at arm’s length would usually enter into, and the ATO goes on to say that it is often also the case that the business is not one capable of division in any commercially meaningful way. The ATO also notes that the Asset Trust may also be a MIT (thereby potentially attracting concessional tax rates for rent and capital gains on taxable Australian property).
More specifically, the ATO is concerned that the Asset Trust may in fact either be conducting a ‘trading business’ itself, or controlling the operating entity (which conducts a trading business) due to economic dependency. This would have ramifications if this would cause the Asset Trust to then become a public trading trust under Division 6C of Part III of the Income Tax Assessment Act 1936, or compromise its status as a MIT.
In addition, where the Asset Trust is a MIT, the ATO is concerned that the rent paid to the Asset Trust may be taxed as non-arm’s length income under Subdivision 275-L of the Income Tax Assessment Act 1997 on the basis that the transactions entered into would not be ones that parties dealing at arm’s length with each other would have entered into.
The ATO also indicates that a so-called rental staple can arise for new businesses which commence to be conducted, a restructure of an existing business, or where an existing business is acquired via the acquisition of certain assets by the Asset Trust and remaining assets by an operating entity.
Synthetic equity structures involve an investment by the trust in an operating company that:
- is not in the form of shares and purports to not provide control over the operating company to the trust; but
- delivers a return contingent on the economic performance of the operating company.
Such extreme arrangements are not common in the infrastructure industry, for example, rents and interest rates are typically not pegged to the turnover or profitability of the operating entity.
A finance trust structure describes a situation where equity from a trust is lent to an operating company, usually at interest. These structures have been a concern to the ATO for many years and have been challenged by the ATO under section 974-80 and subsection 974-70(2) of the debt / equity rules contained in the Income Tax Assessment Act 1997.
However, the added potential concern in TA 2017/1 is the suggestion that equity in the operating entity is less than what it would ordinarily be (by some or all of the loan from the finance trust), which could result in the finance trust controlling the operating entity through financial dependency. For example, the ATO envisages that this could arise where the finance trust can influence the operating company due to its ability to call up the loan potentially causing the operating entity to become insolvent. Where the finance trust can be said to control the affairs or operations of the operating entity in respect of the carrying on by the operating entity of a trading business, Division 6C of the Income Tax Assessment Act 1936 would apply to the finance trust if it were otherwise a public unit trust as defined.
The royalty staple structure involves the trust acquiring intangible property which is licensed across to an operating entity and the operating entity pays a royalty to the (non-public) trust. The royalty is said to be subject to only royalty withholding tax when distributed to a non-resident.
The ATO considers that these arrangements may in fact not involve royalties for tax purposes. These arrangements are unlikely to be present in the infrastructure industry.