On 26 April 2013 the Federal Court of Australia handed down a decision on the treatment of a disposal of shares in an Australian listed mining company by a Cayman resident limited partnership. In the decision, Edmonds J confirmed that the International Tax Agreements Act 1953 (Cth) (and specifically the Convention between the Government of Australiaand the Government of the United States of America for the Avoidance of Double Taxation and the Prevention of the Fiscal Evasion with respect to Taxes on Income (the Aus/US Convention)) prevents Australia from taxing a Cayman limited partnership where the limited partners are resident in the US.
What this means for foreign investors
The treaty issue
In Taxation Determination TD 2011/25 (commonly referred to as the ‘look-through’ determination of the four tax determinations issued in the fall-out from the TPG / Myer disposal) the Commissioner confirmed that he will look to the residence of the limited partners in a fiscally transparent foreign limited partnership in forming a view as to whether the business profits article of Australia’s tax treaties apply to allocate taxing rights over those profits.
This decision takes the concept one step further, as it holds that the Commissioner is precluded from assessing a fiscally transparent foreign limited partnership on gains made from the alienation of Australian property in circumstances where its limited partners are resident in a treaty country.
While the Aus/US Convention allocates taxing rights to Australia in respect of gains made by the limited partners in these circumstances, we query whether Australian domestic law enables the Commissioner to tax the partners directly. This outcome follows, in part, from the well-established position that Australian tax law regards a Cayman limited partnership as a company, and the limited partners as shareholders rather than partners. In applying Division 855 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997), the Commissioner would appear to be bound to have regard to the limited partnership as a company. It is also unclear how a revenue gain would fall for taxation in these circumstances under domestic law.
In the facts before the Court, the Commissioner had not sought to assess the limited partners directly on the gain, and while Edmonds J held that the Aus/US Convention allowed Australia taxing rights over gains made on the alienation of property by the limited partners, the Court was not asked to determine whether this is even possible under Australian domestic law. In our view, if the Australian domestic law does not allow for taxation of the limited partners directly on such a gain, unless the Commissioner is able to treat the treaties as a ‘sword’ (more specifically, the alienation of property articles in the treaties as a separate taxing right) it follows that there is an inconsistency between the application of the treaties, and the application of Australian domestic law. This would mean that no taxpayer may be liable to taxation on a gain on the alienation of property in these circumstances. This is a position which warrants further consideration, particularly where the value of the underlying Australian investment is principally Australian land.
The taxable Australian real property issue
The case sets out an important analysis of the valuation methodologies that the Court will apply in determining whether a company passes the principal asset test in s 855-40 of the ITAA 1997. Specifically, Edmonds J favoured an approach whereby assets such as mining information and plant (which are not considered “land” assets for the purposes of the test) are severable and distinct assets from mining rights and exploration tenements (which are considered land for the purposes of the test). This resulted in the somewhat unexpected outcome that a gain made by a non-resident investor on the disposal of shares in an Australian gold mining company was not taxable in Australia.
The case, Resource Capital Fund III LP v Commissioner of Taxation [ 2013 ] FCA 363, concerned the disposal by the applicant (RCF) of shares comprising greater than 10% of the capital of St Barbara Limited (SBM) in two parcels in July 2007 and January 2008 for a total gain of approximately $58m.
RCF is a limited partnership formed in the Cayman Islands under Cayman law, with more than 97% of the committed capital of the partnership held by US residents (principally funds and institutions). SBM, at the relevant time, was an ASX listed company that conducted a gold mining enterprise on mining tenements in Australia owned by it, using plant, equipment, mining information and other assets held by it. The mining tenements were “taxable Australian real property” (TARP) of SBM for the purposes of Division 855 of the ITAA 1997 which deals with capital gains and foreign residents, while the other assets of SBM were not.
In November 2010, the respondent (Commissioner) issued RCF:
- a notice of assessment for the income year ended 30 June 2008 which included a net capital gain in the sum of $58,250,000 (Assessment); and
- a notice of assessment of administrative penalty in the sum of $13,106,250 (being 75% of the tax liability).
RCF lodged objections against the assessments, and appealed to the Federal Court against the Commissioner’s deemed disallowance of the objection.
The Federal Court judgment
Edmonds J considered two issues in the appeal:
- whether the Assessment could properly be issued to RCF, or whether the Assessment is precluded by the Aus/US Convention; and
- whether any capital gain is required to be disregarded by Division 855 of the ITAA 1997 because the sum of the market values of SBM’s TARP assets did not exceed the sum of the market values of SBM’s other assets as at the dates of disposition of RCF’s shares in SBM.
In relation to the first issue, his Honour considered the terms of the Aus/US Convention and commentary on the OECD Model Tax Convention on Income and on Capital 2005 (OECD Model), and concluded that RCF is not a resident of the US for the purposes of the Convention (ie, RCF itself is not resident in the US for the purposes of its tax and therefore is not a resident of the US for the purposes of the Aus/US Convention). In doing so, Edmonds J rejected the Commissioner’s argument that RCF was a resident of the US for the purposes of the Aus/US Convention. According to Edmonds J, RCF could not be taxed because of its fiscal transparency.
His Honour confirmed the position that Australian domestic law treats RCF as a company, and the limited partners taxed like shareholders in a company. As a consequence of this outcome, under Australian domestic law it would be appropriate to tax RCF on any capital gain arising on the disposal of shares in SBM (subject to whether or not that gain is disregarded by operation of Division 855 of the ITAA 1997). However, regard is to be had to the tax transparent nature of the entity for the purposes of applying the treaties.
The Commissioner submitted that paragraph 7 of Article 13 of the Aus/US Convention was broad enough to permit Australia to tax gains of every type, including gains from the disposition of real property, irrespective of whether the disposing party is a resident of the US for the purposes of the Aus/US Convention. This was rejected.
In relation to the second issue, Edmonds J considered the valuation evidence before the Court and concluded that SBM did not pass the principal asset test in s 855-30 of the ITAA 1997, notwithstanding that it was in the business of running an Australian gold mining operation. Edmonds J set out an important analysis of the valuation methodologies that the Court will apply in determining whether a company passes the principal asset test. On the facts before the Court, Edmonds J found that the valuable mining information and plant used in the business did not constitute TARP, with the result that the value of SBM’s non-TARP assets was more than the value of its TARP assets (ie, its land and mining rights).