After a lengthy gestation period, on 27 March 2018 Treasury released a package of measures that are targeted at addressing previously identified tax concerns with the use of stapled structures. Although stapled structures commonly used by institutional investors in land-rich industries are the focus of the changes, it also includes measures with much broader application including limitation of tax concessions for foreign pension funds and sovereign wealth funds, the tax treatment of structures with multiple layers of debt and certain investments in agricultural land.
The changes follow the ATO's release of a taxpayer alert on the use of stapled structures in January 2017 (see our previous alert) and a Treasury Consultation Paper in March 2017. The changes, if implemented, will affect many existing inbound investment structures. Although there is some grandfathering of existing investments, this is limited (in most cases to a seven year transition period).
1. 30% tax rate for many stapled structures
The headline measure would increase the managed investment trust (MIT) withholding tax rate from 15% to the company tax rate (currently 30%) for fund payments derived from certain active business income. This measure is primarily targeting structures that convert active business income into passive income, in particular, through:
- cross staple rental payments;
- cross staple payments made under total return swaps or other financial arrangements; and
- MITs in receipt of distributions from a trading trust.
The higher withholding tax rate will not apply where the stapled operating entity receives rent from third parties and this is merely passed through as rent to the trust, or where only a small proportion of the gross income of the trust relates to cross staple payments. The logic behind this exemption is that the payment has not been converted from active business income. However, there is little detail at this stage on what types of third party payments would constitute "rent" or even what entities will be considered third parties for the purposes of this exclusion.
There will also be a 15 year exemption for certain infrastructure projects, but this would be limited to new investment in economic infrastructure approved by the Government, referred to in the paper as "nationally significant infrastructure". The conditions that will need to be met to access this concession are yet to be settled and will be the subject of further Treasury consultation, but are likely to include restrictions on aggressive cross staple pricing.
At this stage, it appears that the 30% withholding tax rate could apply to MITs that are not stapled if they are receiving distributions from other trusts that carry on a trading business, a change which would affect many consortium investment structures.
2. Other measures affecting foreign investors
The Treasury paper also includes a number of amendments that go beyond staples. These include:
- limiting the withholding tax exemptions for foreign pension funds to interest and dividend income derived from portfolio investments only (described by Treasury as ownership interests of less than 10% where there is no influence over the entity’s key decision-making).
- creating a legislative framework for sovereign wealth funds and other foreign government investors, effectively limiting the administrative concessions such investors have enjoyed in the past. Under existing administrative practice, such investors would typically be immune from Australian tax on investments of up to approximately 20% in an entity. The proposed framework would limit the immunity to interests of less than 10% where there is no influence over the entity’s key decision-making. The framework would also result in sovereign investors being taxed on any active business income derived through trusts.
- amending the thin capitalisation rules to prevent double gearing structures. These proposals are targeted at structures that involve multiple layers of flow-through entities (e.g., partnerships and trusts) each issuing debt to sidestep existing thin capitalisation limits. This would be addressed by lowering the thin capitalisation associate entity test from 50% to 10% for interests in flow-through entities, and testing gearing against the underlying assets for interests in any entity. These amendments will have effect from 1 July 2018.
- excluding agricultural land from qualifying as an "eligible investment business", such that the 15% MIT withholding rate may no longer be available to rent and capital gains derived from agricultural land.
All measures, other than the thin capitalisation amendments, will commence on 1 July 2019 subject to the transitional periods discussed below.
3. Transitional periods
No transitional relief is available for the thin capitalisation measures.
However, transitional relief of:
- seven years is available for arrangements currently in place on 27 March 2018; and
- 15 years is available for certain economic infrastructure staples (as discussed above, it remains to be seen what investments will fall within the definition of economic infrastructure).
This means that the earliest these changes will apply is 1 July 2026 (with the exception of the amendments to the thin capitalisation rules).
During the transition period:
- (following implementation of the package) the general anti-avoidance rule will not apply with respect to the choice of a stapled structure to obtain a deduction for cross staple rent (this leaves other cross stapled arrangements, such as cross staple royalties, within the scope of the anti-avoidance rules);
- the concessional tax rates will only apply to investments already made (or, in certain circumstances, committed to) as at 27 March 2018;
- sovereign investors that have obtained a ruling from the ATO on sovereign immunity for a particular investment which extends beyond the transitional period can access the transitional period until the expiry of the ruling;