RE: Exposure Draft - Treasury Laws Amendment (Stapled Structures and Other Measures) Bill 2018

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Susanna Glenn
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01 June 2018 Crprate and Internatinal Tax Divisin The Treasury Langtn Crescent Sydney NSW 2000 Dear Sir/Madam, RE: Expsure Draft - Treasury Laws Amendment (Stapled Structures and Other Measures) Bill

1 01 June 2018 Crprate and Internatinal Tax Divisin The Treasury Langtn Crescent Sydney NSW 2000 Dear Sir/Madam, RE: Expsure Draft - Treasury Laws Amendment (Stapled Structures and Other Measures) Bill 2018 AVCAL welcmes the pprtunity t prvide cmments t the Treasury n the expsure draft legislatin titled Treasury Laws Amendment (Stapled Structures and Other Measures) Bill 2018 (the Expsure Draft). AVCAL represents the private equity (PE) and venture capital (VC) industry in Australia, which has a cmbined ttal f arund $30 billin in funds under management n behalf f dmestic and verseas investrs, including a significant prtin frm ffshre superannuatin and pensin funds (FSFs) and svereign wealth funds (SWFs). Over the three-year perid frm FY2015 t FY2017, 67% f funds raised by Australian PE funds came frm ffshre investrs. In the same perid, almst 30% f ttal funds raised by Australian PE funds came frm FSFs and SWFs. We understand that the key bjectives f the prpsed refrms are t imprve the integrity f the incme tax law fr arrangements invlving stapled structures and t limit access t tax cncessins fr certain freign investrs. Hwever, the prpsed drafting ptentially creates excessive uncertainty and cmplexity fr FSFs and SWFs that invest in Australian PE, and places additinal administrative burdens n this vital surce f capital fr dmestic PE fund managers. Overall, ur submissin seeks further clarificatin n the applicatin f these laws t prvide certainty, clarity and guidance fr FSFs, SWFs, and Australian PE fund managers. Our respnse as set ut belw fcuses n Schedule 3 (measures that deal with Superannuatin funds fr freign residents withhlding tax exemptin) and Schedule 4 (measures that deal with Svereign immunity) f the Expsure Draft, and respective Chapters 3 and 4 f the explanatry material. 1

2 1. Superannuatin funds fr freign residents withhlding tax exemptin sectin 123B(3CA) This sectin f ur submissin addresses the prpsed drafting f sectin 128B(3CA) f the Incme Tax Assessment Act 1936 (ITAA 1936). The stated plicy bjective f this prvisin seeks t imprve the integrity f the incme tax law t limit the circumstances in which the withhlding tax exemptin in sectin 123B(3)(jb) f the ITAA 1936 is available t FSFs. The current drafting f subsectin 128B(3CA) wuld deny an exemptin frm Australian dividend and interest withhlding tax where the ttal participatin interest (TPI), within the meaning f sectin f Incme Tax Assessment Act 1997 (ITAA 1997), f an FSF in an entity frm which the FSF derived incme (the paying entity ) is 10% r mre. Sectin f the ITAA 1997 prvides that: An entity s ttal participatin interest at a particular time in anther entity is the sum f: a) The entity s direct participatin interest in the ther entity at that time; and b) The entity s indirect participatin interest in the ther entity at that time. Fr these purpses, sectin f the ITAA 1997 prvides that in determining an entity s indirect participatin interest, the interest must be traced thrugh intermediate entities. The reference in the current drafting f sectin 128B(3CA) t the entity frm which the superannuatin fund derived the incme is ambiguus and shuld be clarified t cnfirm that in the cntext f a managed fund / trust, it is the direct participatin interest in that managed fund / trust that is the relevant interest and nt the indirect participatin interest in the underlying investee entities. AVCAL believes that an additinal example is warranted fr inclusin in the explanatry material which wuld clarify the applicatin r nn-applicatin f sectin 128B(3CA) in the fllwing scenari: Scenari cmbinatin f direct and indirect interest in a paying cmpany An FSF has a direct interest (debt r equity) in an Australian cmpany (AusC) that makes dividend and/r interest payments. The FSF als invests int a cllective investment vehicle 1 which makes distributins f dividend and interest incme, including incme derived frm its investments in underlying Australia prtfli cmpanies which include AusC. In the circumstances where AusC is paying a dividend r interest n membership interests/debt interests it has issued, the relevant paying entity, fr the purpses f the prpsed sectin 128B(3CA), will be AusC. The FSF s direct participatin interest in the Australian cmpany will be the relevant interest fr the purpses f calculating TPI in the cntext f the prpsed sectin 128B(3CA). 1 The reference t cllective investment vehicles is intended t cver all trusts and partnerships used fr investment purpses, including managed investment trusts, crprate and limited partner cllective investment vehicles, venture capital limited partnerships, and early stage venture capital limited partnerships. 2

3 In the circumstances where that dividend and interest incme is als received by the cllective investment vehicle and is included in its net incme, and then distributed by that cllective investment vehicle, the relevant paying entity fr that incme and dividend incme shall be the cllective investment vehicle and nt AusC. The FSF s interest in the cllective investment vehicle is the relevant interest fr the purpses f determining its TPI in the paying entity. Under the prpsed drafting f sectin 128B(3CA), tw different methds are used fr calculating the FSF s TPI: in respect f interest and dividend incme distributed by the cllective investment vehicle, the FSF s TPI is nly its interest in the managed fund (being the paying entity); and in respect f interest and dividend incme paid by AusC t the FSF (due t its direct interest in AusC), the FSF s direct and indirect participatin interests are required t be aggregated fr the purpses f calculating its TPI. It is ur view that the aggregatin f the direct and indirect participatin interests in an underlying Australian prtfli cmpany wuld be inapprpriate in these circumstances. Relevantly, where FSF s indirect participatin interest is held thrugh a cllective investment vehicle and that interest has already been tested as a direct participatin interest in that cllective investment vehicle, this interest shuld nt be cnsidered again in determining the FSF s TPI in the underlying Australian prtfli cmpany. Under the prpsed drafting, it may be interpreted that an FSF s direct participatin interest in a cllective investment vehicle will be duble cunted (i.e. at the cllective investment vehicle level and at the Australian prtfli cmpany level) fr the purpses f calculating TPI in tw separate entities. This sectin f the Expsure Draft needs t be clarified, especially with regard t the meaning f the entity frm which the superannuatin fund derived the incme, which culd be interpreted t mean either the cllective investment vehicle r the prtfli cmpany. Further, if such an interpretatin f the current drafting is made, it wuld be very impractical in the cntext f a cllective investment vehicle as an investr cannt cntrl the investments f such a fund and cannt at all times be in a psitin t cmpute its indirect interest in an underlying Australian prtfli cmpany. The tw investments by an FSF in this scenari are inherently distinct investments and carry different risks, riskreturn prfiles, and expsures: the investment in the cllective investment vehicle is a passive investment; and the investment in the underlying Australian prtfli cmpany is an investment int the underlying assets and business f the cmpany. In these circumstances, distributins n a direct interest and an indirect interest represent tw separate payments derived frm tw distinct paying entities. Aggregating such interests t determine whether an exemptin t withhlding tax applies may unintentinally disadvantage an FSF that hlds bth investments and has significant implicatins t the PE and funds management sectrs. The riginal intentin f the prpsed amendments is t limit the withhlding tax exemptin fr an FSF t prtfli investments nly. This bjective can be achieved withut causing unnecessary administrative and cmpliance burdens fr FSFs, fund managers, and Australian cmpanies impsed by the prpsed sectin 128B(3CA). By excluding an FSF s indirect participatin interests fr the purpses f calculating TPI in the underlying Australian 3

4 prtfli cmpany in limited circumstances (such as in the c-investment scenari described abve and illustrated further in Example 1 belw), administrative csts and cmpliance burdens can be alleviated in the fllwing ways: the cllective investment vehicle shuld nt be required t cntinuusly mnitr an investr s indirect interest in an investment where that investr als has a direct investment int that prtfli cmpany; the prtfli cmpany shuld nt be required t cntinuusly mnitr the investments f an FSF investr t determine whether it hlds any indirect investments in the prtfli cmpany thrugh cllective investment vehicles; and the FSF will nt be required t mnitr all f the prtfli investments f a cllective investment vehicle t ensure that the fund manager is nt making additinal investments int cmpanies in which the FSF already has a direct investment in. Prpsed amendment t sectin 123B(3CA) Fr the reasns nted abve, we believe that the prpsed sectin 128B(3CA) be amended s that an FSF s indirect participatin interests held thrugh a cllective investment vehicle shuld be excluded fr the calculatin f TPI in an Australian paying entity in the cntext f this particular sectin f the legislatin: Paragraph (3)(jb) applies t incme nly if the ttal participatin interest (within the meaning f the Incme Tax Assessment Act 1997) f the superannuatin fund mentined in subparagraph (3)(jb)(i) in the entity frm which the superannuatin fund derived the incme: a) is less than 10% at the time the payment mentined in subparagraph (3)(jb)(ii) is made; and b) is less than 10% thrughut any 12 mnth perid that began n earlier than 24 mnths befre that time and ended n later than that time, fr the purpses f paragraph (a) and (b) abve, disregard a superannuatin fund s indirect participatin interest in the entity t the extent that: a) the intermediate entity is a cllective investment vehicle; b) the superannuatin fund derives dividend and/r interest incme frm that intermediate entity; and c) that participatin interest has already been used in determining the superannuatin fund s ttal participatin interest in that intermediate entity fr the purpse f applying these prvisins t that intermediate entity. * Fr the purpses f paragraph (b) abve, where an interest is held fr a perid f less than 12 mnths, the interest held is deemed t be 0% fr the remainder f the 12 mnth perid. Amending sectin 128(3CA) as utlined abve will prvide the greatest clarity in relatin t the implementatin f the prpsed legislatin and its riginal plicy bjectives. In the absence f adpting the abve amendment, we recmmend that Treasury cnsiders the inclusin f the fllwing example in the explanatry material t further clarify the circumstances and applicatin f the prpsed sectin f legislatin. 4

5 Example [3.X]: C-investment in an Australian Cmpany FSF interest / dividends 9% Aus Fund (the paying entity) 9% direct c-investment interest / dividends Debt 30% AusC FSF is a superannuatin fund fr freign residents. FSF hlds 9% f the issued units f Aus Fund, which is a cllective investment vehicle. Aus Fund hlds a 30% interest in AusC, an Australian resident cmpany it derives dividend and interest incme n this investment. FSF als hlds a 9% direct interest in AusC n which dividend and interest is paid directly t FSF. There are n ther factrs present which indicate FSF can influence Aus Fund in any way. FSF s TPI in the relevant paying entities is as fllws: Aus Fund 9%; and AusC 9% (n the basis that the indirect participatin interest f 2.7% (9% multiplied by 30%) is disregarded as Aus Fund is a cllective investment vehicle fr the purpse f sectin f the ITAA 1997 and was already used t determine FSF s TPI in Aus Fund). Accrdingly, any dividends r interest paid by Aus Fund t FSF and AusC t FSF will be exempt frm dividend and interest withhlding tax under paragraph 128B(3)(jb). 5

6 2. Superannuatin Funds fr freign residents withhlding tax exemptin Sectin 128B(3CB) AVCAL believes that the prpsed deeming prvisins in sectin 128B(3CB) as currently drafted culd unintentinally capture a wide range f cmmercial relatinships and arrangements, including participatin by FSFs n investment advisry bards and cmmittees. 128B(3CB) - fr the purpses f paragraph (1)(d), treat ne entity (the first entity) as hlding a ttal participatin interest in anther entity (the secnd entity) f 10% at a time if, at that time: a) The first entity hlds any f the fllwing kind f interest in the secnd entity: i. A membership interest ii. iii. A debt interest A nn-share equity interest; and b) That interest cnfers r thse interests cnfer a right n the first entity: i. T vte at a meeting f the Bard f Directrs (r ther gverning bdy) f the secnd entity; r ii. iii. T participate in making financial, perating and plicy decisins in respect f the secnd entity; r T deal with assets f the cmpany. Firstly, further clarificatin is required in respect f sectin 128B(3CB) t determine which entity is the first entity (i.e. whether the first entity is the FSF). Secndly, the prpsed drafting f sectin 128B(3CB)(b) is brad and creates ambiguity in determining whether a deemed TPI f 10% shuld be applied. Fr example, it may be deemed that an FSF has a TPI f 10% where it has a psitin n an investment advisry bard (IAB) f a cllective investment vehicle, despite that psitin nt hlding any influence ver key decisins made by the fund r its managers. Mst PE funds have an IAB which generally allws apprvals t be btained fr certain actins f the GP r trustee that are utside their pre-agreed investment mandate and which culd have the ptential t affect the nature f the investr s investment in the fund. Bradly, the purpse f such an IAB is t allw the GP r trustee t seek apprvals in a manner that is less burdensme frm a timing and lgistical perspective than a frmal amendment t, r waiver f, the fund dcuments. The IAB merely prvides advice r makes recmmendatins t the GP r trustee. The GP r trustee is nt bund t fllw the advice r recmmendatins f the IAB, but rather it wes a separate fiduciary duty and bligatin t the investrs t make independent decisins in respect f the fund s financial, perating and plicy matters. Accrdingly, the rights cnferred n the members f an IAB shuld nt be captured under the prpsed sectin 128B(3CB)(b)(ii). The example utlined belw illustrates this case. Similarly, we submit that Example 4.3 f the explanatry materials (while it relates t SWFs, it culd equally apply t FSFs) des nt reflect cmmercial practice. Typically the IAB f ABC Unit Trust wuld nt have the rights as listed in prpsed sectin 128B(3CB)(b). Instead, such decisins can nly be made by AusC s Bard f Directrs exercising their independent minds. Accrdingly, SWF s ttal participatin interest in ABC Unit Trust in this scenari shuld nt be deemed t be 10%. 6

7 T further imprve clarity n this particular issue, we believe that the fllwing example shuld be included in the explanatry material: Example [4.X]: Interest in an Investment Advisry Bard interest / dividends FSF 9% Rights t participate in financial, perating and plicy decisins Aus Fund (the paying entity) Advisry Cmmittee interest / dividends Debt 30% Prtfli C FSF is a superannuatin fund fr freign residents. FSF hlds 9% f the issued units f Aus Fund, which is a cllective investment vehicle in the frm f a trust. Under Aus Fund s trust deed, any investr with an equity interest f 9% r mre is entitled t appint an individual t an Advisry Bard f Aus Fund. Members f the Advisry Bard can participate in making investment recmmendatins t Aus Fund including allwing the trustee t make certain investment decisins utside its agreed mandate. Such recmmendatins and apprvals d nt bind the trustee. The trustee f Aus Fund will cnsider the recmmendatins made by the Advisry Bard but in line with its fiduciary bligatins will make an independent assessment prir t making any investments. Accrdingly, FSF s interest in Aus Fund des nt cnfer the right t: vte at a meeting f the Bard f Directrs (r ther gverning bdy) f the secnd entity; r participate in making financial, perating and plicy decisins in respect f the secnd entity; r deal with assets f the cmpany. Based n the circumstances utlined abve, sectin 128B(3CB) shuld nt apply with the result that the FSF is taken t have a ttal participatin interest f 10%. 7

8 3. Svereign immunity SWFs are becming an increasingly imprtant surce f capital fr numerus Australian businesses that attract investment thrugh Australian PE fund managers. These svereign entities cntributed arund 18% f all Australian PE funds raised ver the FY perid. It is imprtant t ensure that this institutinal investr segment isn t disadvantaged when making investments int dmestic PE, bth thrugh fund structures and directly int lcal businesses. The stated plicy bjective f Schedule 4 f the Expsure Draft and Chapter 4 f the explanatry material (bth relating t svereign immunity) is t imprve the integrity f the incme tax law t limit access t tax cncessins fr freign investrs by cdifying and limiting the scpe f the svereign immunity tax exemptin. We believe that, as utlined abve with respect t certain withhlding tax exemptins fr FSFs, ur views and prpsals with respect t the prpsed sectin 128B(3CA) shuld apply equally t the prpsed drafting in sectin (1)(d) f the ITAA 1997, and that ur views and prpsals with respect t the prpsed sectin 128B(3CB) apply equally t the prpsed drafting in sectin (2) f the ITAA Based n ur interpretatin, the current drafting f sectin (1)(d) f the ITAA 1997 lks t aggregate the interests f all svereign entities f a cuntry such that the 10% requirement cannt be breached n a whle f cuntry basis. Hwever, there are ften instances where PE funds raise capital frm a number f svereign entities (fr example, entities that perate either at a state r federal level) frm the same cuntry. These entities may be wned by different arms f a gvernment, r by different levels f gvernment, and will ften have different bjectives set ut in their charters r mandates. There are many ther examples frm arund the wrld, including in Asia, the Middle East, and Nrth America f different SWFs established fr distinct purpses and verseen by separate gvernance framewrks, althugh they may be cntrlled by the same freign gvernment. T pl these separate investrs tgether fr tax purpses may cause undue uncertainty and dissuade this key investr segment frm cmmitting mre capital t Australian PE funds, r preclude them frm direct investing in Australian businesses altgether. In light f this, we believe that the current drafting in relatin t svereign immunity requires further cnsideratin and clarificatin. 4. Interactin f svereign immunity with VCLPs Venture capital limited partnerships (VCLP) are an imprtant type f fund vehicle fr the PE and VC industry here in Australia. As currently drafted, it is unclear whether incme derived by a svereign entity frm a prtfli cmpany thrugh a VCLP is eligible fr svereign immunity based n current drafting f the prpsed paragraph (1)(a). T clarify this uncertainty, and cnsistent with the plicy intentin f the law t limit svereign immunity t circumstances f passive prtfli investments, we prpse that the fllwing language be added t paragraph (1)(a): (a) that amunt is derived, received r made frm a trust r cmpany (the paying entity), including thrugh an interpsed partnership; Additinally, it is standard industry practice that VCLPs are part f structures that use cmpanin trusts, which are typically managed investment trusts (MITs). Based n the current Expsure Draft, incme derived, received r made frm an MIT wuld be eligible fr svereign immunity (subject t satisfying the ther relevant requirements) whilst svereign immunity may nt be available fr exactly the same prfile f investment if it were t be made by a svereign entity thrugh a VCLP. This appears t be an anmalus result, given the VCLP regime is designed t incentivise investment, particularly frm freign tax exempt investrs such as SWFs (see paragraph (1)(a) f the ITAA 1997). 8

9 The abve clarificatin in the law is als relevant t incme received frm Early Stage Venture Capital Limited Partnerships (t the extent it is nt therwise nn-assessable nn-exempt incme) and Australian venture capital funds-f-funds. 5. Abut AVCAL and Australia s private equity and venture capital industry AVCAL represents PE and VC industry in Australia, which has a cmbined ttal f arund $30 billin in funds under management n behalf f dmestic and verseas investrs including Australian and ffshre superannuatin and pensin funds, svereign wealth funds, and family ffices. VC and PE firms invest billins f dllars in early stage and established businesses spanning acrss almst every sectr f ur natinal ecnmy. In the financial year ending 30 June 2017 alne, PE and VC invested arund $3.6 billin int Australian businesses. An April 2018 study by Delitte Access Ecnmics prvides sme deeper insights int the ecnmic cntributin f PE including: In FY2016, private-equity backed businesses cntributed $43 billin in ttal value added t the Australian ecnmy equal t 2.6% f Australian GDP; PE-backed businesses supprted 327,000 FTE jbs (172,000 directly, and 155,000 indirectly); In FY2016, private equity-backed businesses added almst 20,000 FTE jbs, accunting fr 11% f ttal Australian emplyment grwth in FY2016; PE-backed businesses typically delivered annual revenue grwth f 20%, while bsting the size f their wrkfrce by 24%; Mre than 85% f private-equity businesses intrduced sme type f prcess r prduct innvatin in FY2016, far greater than the average prfile f nn-pe backed businesses. 6. Next steps We wuld like t thank yu fr the pprtunity t prvide a submissin in relatin t the Expsure Draft and explanatry material. If yu wuld like t discuss any aspect f this submissin further, please d nt hesitate t cntact me r Ksta Sinelnikv (AVCAL s Plicy & Research Manager) n Yurs sincerely, Yasser El-Ansary Chief Executive AVCAL 9

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