The ATO has kicked off 2017 with a taxpayer alert which states that it will be targeting certain stapled groups. Taxpayer Alert TA 2017/1 is expected to lead to more audits for affected groups (for which they should be preparing) but more guidance will be needed from the ATO before the full ramifications are known.
The ATO also released an updated version of its 2015 document, “Privatisation and Infrastructure – Australian Federal Tax Framework”. This document sets out a range of infrastructure-related tax issues (and the ATO's views on them) including in connection with privatisations.
Businesses and investors who will be most affected by the ATO's focus on staple arrangements
TA 2017/1 will be of particular interest to infrastructure groups and their investors (though it would seem that the "synthetic equity" and "royalty staples" are of less relevance).
That said, TA 2017/1 is not limited to infrastructure investment structures and focuses more broadly on "arrangements which attempt to fragment integrated trading business in order to re-characterise trading income into more favourably taxed passive income".
Foreign investors should in particular pay close attention to TA 2017/1 as the position of the ATO on these structures could impact their after tax return.
Lenders will also need to examine the ramifications of TA 2017/1 carefully. Changes in tax interpretations which result in additional tax being imposed on a structure have the potential to affect the capacity of the structure to service debt.
What kinds of staple arrangements are carved out?
Those arrangements which are expressly excluded are:
- 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 described in TA 2017/1; and
- Privatised businesses which are effectively land (and land improvement) based or heavily reliant on particular land holdings and related improvements. It is noted in TA 2017/1 that such privatisations are typically subject to taxpayer engagement with the ATO in any event and are heavily scrutinised.
TA 2017/1 also acknowledges the existence of structures, such as hotel stapled structures, where the landowner leases the building to a stapled operating entity which in turn makes that building (or part thereof) available to an independent user. Further, a common observable market practice already exists in that industry for building owners to lease those types of buildings to unrelated third parties to carry on the same type of business the operating entity carries on.
What staple arrangements are in the ATO's sights?
Staple type: Finance staple.
Key features: A thinly capitalised operating entity is the beneficiary of an interest bearing cross staple loan from an asset trust. The asset trust makes the loan out of the proceeds of an equity issuance. The operating entity claims a tax deduction for the interest and the interest income is distributed to asset trust's investors.
ATO concerns:
- No interest deductibility for operating entity due to operation of sections 974-70 or 974-80 (this is not a new concern) and was raised in the EM accompanying the introduction of the debt/equity rules.
- Whether the asset trust is a 6C trust because it can "control" the operating entity - eg. the operating entity's continuation as a going concern is contingent on asset trust not triggering an insolvency in the operating entity.
Staple type: Synthetic equity staple.
Key features: Profit equivalent / turnover equivalent and/or amounts having a similar result in substance or effect as the above are paid by the operating entity to the asset trust. The operating entity claims a deduction for those payments and the asset trust and/or its investors may also consider that it/they qualify as a MIT.
ATO concerns:
- Deductibility under section 8-1 or Division 230 of the cross staple payment.
- Division 6C concerns due to asset trust being exposed to the success and/or failure of the operating entity's underlying business operations.
Staple type: Royalty staple.
Key features: The asset trust (which holds IP, mining tenements, industrial equipment or other assets capable of producing a royalty) receives a royalty from an operating entity. The operating entity claims a deduction for the payment while the asset trust (which has an investors base which prevents the trustee being taxed under Division 6C) distributes the royalty income to investors (usually with the benefit of a capped treaty rate).
ATO concerns: Whether the assets in question are capable of producing a royalty and even if that is the case, whether the payments in question are in fact royalties.
Staple type: Rental staple.
Key features: The asset trust holds purported land or fixtures which are leased to the operating entity (the operating entity claims a deduction for those lease payments). The separation of the assets are not typical transactions which third parties acting at arm's length would ordinarily enter into and it is often also the case that the business is not one capable of division in any commercially meaningful way. The asset trust and/or its investors may also consider that it/they qualify as a MIT.
ATO concerns:
- Whether Division 6C is enlivened - for example because of control issues, the assets of the asset trust are not "land", whether the requisite purpose for investing in land exists and whether the income of asset trust should be viewed as recharacterised trading business income.
- Whether the Asset Trust and/or its investors qualify as a MIT and whether the cross staple payment could be non-arm's length income under the attribution MIT rules.
Why is the ATO focusing on these staple arrangements?
These structures should not be considered unique or recent innovations, but it would appear that the Commissioner's concerns with them have been exacerbated by the increasingly concessional tax regime applicable to foreign investors, particularly the managed investment trust (MIT) rules.
Further, Australia continues to be a favourable destination for foreign capital. It is that foreign capital which is the primary beneficiary of the MIT rules, with distributions of net rental income typically qualifying for a 15% rate of withholding, rather than suffering tax at a 30% rate of tax. The MIT rules are of particular concern for the ATO under the synthetic equity and rental staple. Under the finance staple and the royalty staple, non-resident investors also may qualify for concessional withholding rates under domestic legislation and/or tax treaties.
Key observations
For those groups which fall within the descriptions above and which have not already been audited, it should be expected that it will now only be a matter of time before such an audit commences, so we would urge them to start getting ready now.
Further guidance and development of the ATO's views on these matters (which is foreshadowed in TA 2017/1) is urgently required. With the increasing demand for complex and costly infrastructure, and with Australia seeking growth drivers in a low growth economy, an uncertain tax environment for infrastructure will be counterproductive and not be attractive to either foreign or domestically sourced capital. Some of these structures are seen as an accepted and well understood for structuring an infrastructure investment. TA 2017/1 might therefore be seen in this regard as moving the goal posts.
The "control" argument put forward by the ATO which affects both the MIT and Division 6C analysis for the asset trust is of particular concern. It would seem that it has the potential to cut across arrangements which might ordinarily be viewed as customary creditor protections and have broader application to more than just the arrangements described in TA 2017/1 or infrastructure groups.
In relation to synthetic equity staples, it will be important to understand the extent of the ATO's concerns. It would seem that the guiding principle and starting point for acceptability of any arrangement would need to be whether the particular rental arrangement could be viewed as arm's length in nature and whether similar arrangements between unrelated third parties may be pointed to.