Taxpayer Alert 2017/1

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Jerome Townsend
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1 Taxpayer Alert 2017/1 Presentation to the Australian Taxation Office s Infrastructure Event, 22 nd March 2017 Jeremy Hirschhorn, Deputy Commissioner, Public Groups, Australian Taxation Office

2 Session overview > Context > Taxpayer Alert TA 2017/1 > History of staples in Australia > The situation internationally > Our concerns > Different compliance risk approach for certain stapled structures > Why we are acting now > What we will be doing in the future 2

3 Context > Traditionally, stapled structures were used in property and land-rich privatisations > We have recently seen proliferation of these structures into: privately constructed and owned infrastructure assets renewable energy agriculture intellectual property, machinery and equipment, and storage facilities > There is clear policy that controlled active business profits cannot conduit through trusts and gain the benefit of MIT withholding rates 3

4 Taxpayer Alert TA 2017/1 > We issued TA 2017/1 to caution against the use of structures that re-characterise trading income into passive income ( fragmented structures ) > These structures are used to reduce the tax rates applicable to trading income. Stapled structures are a common way to achieve this (although stapling is not a mischief) > The Alert is about an informing the market and prevention 4

5 Taxpayer Alert 2017/1 > The Alert is not an attack on foreign investment > Sustainably attracting foreign investment requires ensuring the market has full information about the regulator s stance on issues > An unsustainable tax race to the bottom based on a lack of information does not support foreign investment 5

6 According to PSLA 2008/15 Taxpayer Alerts Taxpayer Alerts provide information that is in the interests of an open tax administration to taxpayers. [6] In publishing a Taxpayer Alert, the ATO is seeking to assist taxpayers who have entered into an arrangement, or who may be contemplating entering into an arrangement, to make informed decisions about their tax affairs. Those taxpayers can seek the ATOs advice in respect of their particular circumstances through a private ruling. [9] Taxpayer Alerts are not limited to arrangements or concerns involving aggressive tax planning. Taxpayer Alerts may also be issued in relation to arrangements which, at the lower end of the scale, may fall short of aggressive tax planning... [26] Taxpayer Alerts do not provide the ATO view on the arrangements they describe [28] 6

7 History of staples in Australia: first wave > A-REIT staples Set up in the 1980s as a response to the enactment of Division 6B and 6C, and designed to eliminate the double taxation of corporate profits Purpose was to aggregate separate but adjacent businesses without triggering Division 6C Involve the derivation of rental income from third parties After the introduction of the imputation system in 1987, A-REITs were used to facilitate tax deferred distributions From 2008, the structure also allows for concessional MIT withholding rates to apply Rental income Stapled Trust 3 rd party tenants Rental income Investors Trading income Stapled Company Trading income 3 rd party customers 7

8 History of staples in Australia: second wave > Privatisation staples Appeared in the 1990s Investors Stapled trust derives most of its rental income from stapled company Structures also allow for distribution of TDDs and concessional 15% MIT withholding rate for foreign investment Assets not in the tax net prior to privatisation Stapled Trust Cross staple rent Stapled Company Trading income 3 rd party customers 8

9 History of staples in Australia: third wave > Finance staples Appeared in the mid-2000s Re-characterise trading income into interest income Trading income re-characterised as flow-through interest, taxed at 0-10% Investors Obtain lower final withholding tax rates of 0-10% Mostly shutdown after section compliance project $11 billion worth still exist New proposals put forward using techniques to avoid section (e.g. using dual trust structures) Often used in conjunction with other types of stapled structures Stapled Trust Interest on cross staple loan Stapled Company Trading income 3 rd party customers 9

10 History of staples in Australia: fourth wave > Rent, royalty and synthetic equity staples Some have been in existence for some time However, there has been a substantial uptick They re-characterise trading income as: - rental or synthetic equity income, which is taxed at 15% - royalty income, which is typically taxed at 5-10% $9.1 billion implemented and 39 structures proposed worth $10.2 billion Synthetic equity staple, if accepted, would place no limit on assets that could be placed in a staple Trading income recharacterised as flow-through rent or synthetic equity income, taxed at 15% or, royalty income taxed at 5-10% Stapled Trust Investors Cross staple rent, royalty or synthetic equity Stapled Company Trading income 3 rd party customers 10

11 The situation internationally > With the exception of Singapore and Hong Kong, staples are unique to Australia > Many jurisdictions have integrity rules specifically targeting stapled structures United States: Section 269B of the Internal Revenue Code Canada: Section 18.3 of the Income Tax Act 1985 (Canada) United Kingdom: Section 342 of the Taxation (International and Other Provisions) Act 2010 (United Kingdom), as well as the UK-REIT legislation that deems rental income from stapled entities to not constitute rental income for REIT purposes 11

12 Our concerns > We are concerned with the fragmentation of an integrated business in order to re-characterise trading income into more favourably taxed passive income > Stapled structures can be a common way to achieve this restructures of existing businesses into stapled structures are of particular concern (but greenfields and acquisitions into staples are also of concern) > Structures of concern that do not involve legal-form stapling include: entities under predominant common ownership fragmenting a business and re-characterising income (not limited to 100% common ownership) a single trust holding a controlling interest in an asset holding trust and a non-controlling interest in an operating entity and the two subsidiaries fragmenting a business and recharacterising income 12

13 Our concerns > Concerns do not arise prospectively only (although we are willing to hear submissions from taxpayers in relation to their individual circumstances) > Our concerns extend to stapled structures designed with a view to a sell-down (to non-residents or tax-favoured investors) > In these situations, Part IVA will be enlivened, at least, upon sell-down to cancel any tax benefit accruing to a future investor 13

14 Our concerns > There was not a level playing field in relation to understanding the ATO s position in relation to fragmentation structures > Some bidders for assets were bidding structures that we viewed as not sustainable under current law > These bidders were often not aware of the potential tax risk of these structures and/or the ATO s concerns, sometimes becoming aware of this in the FIRB process > Other bidders were potentially losing out on assets or feeling forced to bid more tax aggressive structures than they were comfortable with 14

15 Different compliance risk approach for certain stapled structures > TA 2017/1 does not apply to A-REIT staples that derive most of their rental income from unrelated third party tenants; they do not involve fragmentation, rather an aggregation of businesses > Land-rich infrastructure privatisation staples (for example ports, electricity etc) have historically been treated as a special case Subject of intensive one-to-one focus to work out a low compliance risk stance 2013 changes to Part IVA may be relevant Draft Infrastructure Framework sets out the flags on the beach ATO reserves the right to apply Part IVA for those swimming outside the flags 15

16 Different compliance risk approach for certain stapled structures > Some stapled structures involve the use of building premises Policy of allowing flow-through and potential MIT treatment of rental businesses, but not for trading businesses Potential distortions between business models involving the mere holding of building premises for leasing to third party operators, against models that involve the holding and operating of building premises Potential characterisation as an aggregation of separate but adjacent businesses rather than fragmentation of a single business > Generally, where we see such businesses, our concern will focus on the arrangements between entities within the stapled structure (such as ensuring Operating Entity retains a sufficient share of the profits), rather than the stapled structure itself 16

17 Other matters raised by industry > TA 2017/1 is not intended to extend to entities under common ownership engaged in ordinary family dealings where the result of those dealings does not: give rise to interest or royalty income of non-residents facilitate the application of the MIT rules; or ensure the non-application of Division 6C > Private business structuring involves additional or different considerations, some of which may be of concern but need to be addressed in their particular context > Entities that wish to invest into stapled or fragmented structures should engage with us 17

18 Why we are acting now > Proliferation of stapled and fragmented group proposals beyond the traditional first wave A-REIT staples and privatisation staples into: privately constructed and owned infrastructure assets renewable energy agriculture intellectual property, machinery and equipment, and storage facilities > There have been 39 of these proposals with $10.2 billion in assets put to us in the last year > Given the significant uptick in activity, we are worried this might be the tip of the iceberg > We are concerned the value of assets that might be proposed to be placed into a stapled or fragmented structure is very large 18

19 Why we are acting now > Synthetic equity staples, if accepted, would allow any asset to be placed in a staple > Investments using stapled structures often have effective tax rates for foreign investors of between 0-5% and rarely over 10% > This compares with domestic corporates 30% tax rate and super funds 15% tax rate = Actual = Projection* *Projection based on actual stapled group structures proposed, extrapolated forward using the average proliferation profile of first, second, and third wave staples 19

20 What we will be doing in the future > We are planning to release further public guidance addressing: privatisation staples, in the finalised Infrastructure Framework stapled and fragmented structures to which we will prioritise the application of our compliance resources > We will be seeking input from you about what guidance you need > Our promise to those who swim between the flags is that aggressive taxpayers will: be subject to stringent compliance action where relevant, have the ATO s views communicated to FIRB, as appropriate 20

21 Conclusion > We are keen to ensure Australia remains attractive to foreign investors > Part of attracting and keeping foreign investment is ensuring foreign investors have complete information about tax settings, as well as a level playing field this includes the attitude of the regulator and reducing the number of inadvertent disputes this requires compliance action where investments are structured without regard to the Alert > Fragmented structures reduce what are already low effective tax rates available to foreign investors 21

22 Copyright Australian Taxation Office for the Commonwealth of Australia You are free to copy, adapt, modify, transmit and distribute this material as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products). 22

STAPLED STRUCTURES CONSULTATION PAPER MARCH 2017

STAPLED STRUCTURES CONSULTATION PAPER MARCH 2017 Commonwealth of Australia 2017 ISBN 978-1-925504-38-5 This publication is available for your use under a Creative Commons Attribution 3.0 Australia licence,