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30 March 2018 Australia proposes changes to the taxation of stapled structures including measures on foreign investment beyond staples
The announcement comes after a significant period of industry consultation and provides much needed direction, but leaves some critical details outstanding that remain to be clarified.
The transitional provisions included for qualifying existing investments and the new time limited exemption to incentivize construction of nationally significant infrastructure are a positive development. However, the measures go much further than simply "levelling the playing field" between local and foreign investors.
Affected taxpayers should respond to the Federal Government and be active in consultation on the implementation of legislation. Australia is a net capital importer and has long maintained policy settings reflecting the importance of an open economy and attracting foreign capital. The size of the infrastructure investment requirement in coming decades is significant, with various sources estimating Australia's infrastructure deficit to be up to AU$800 billion in the next 10 years. Therefore, it is important that tax settings maintain Australia's global competitiveness for foreign capital. However, a simplistic benchmarking of the appropriate Australian tax impost to the corporate tax rate as justification for these measures ignores global competition for these funds in the sector. Stapled structures are used for property and land-based traditional economic infrastructure investments – such as privatized electricity assets, ports and toll roads. A recent expansion of stapled structures for asset classes, such as renewables and agribusiness, triggered the Government's concerns notwithstanding that the structures played an important role in facilitating the development of critical infrastructure and State Government asset recycling initiatives. The reforms also create uncertainty for ongoing Australian Taxation Office (ATO) reviews and audits of existing stapled structures – particularly for structures eligible for transitional relief. The ATO should clarify its approach on these matters.
Nevertheless, foreign investors into these structures may be affected by the changes to broader concessions. Thin capitalization changes to prevent foreign investor use of "double gearing" structures – from 1 July 2018 Changes to the thin capitalization debt deduction rules are intended to prevent perceived tax avoidance using "double gearing" structures. Structures using multiple layers of "flow-through" entities (for example, trusts and partnerships), each issuing debt against the same underlying asset whether or not held in a stapled structure, are targeted. Absent these changes, the gearing lowers the investment's effective tax rate because the interest payments are only subject to a 10% (or lower) withholding tax rate for foreign investors. The reform expands the thin capitalization associate entity test (for determining associate entity equity and associate entity debt) to 10% or more (down from 50% or more) for interests in flow-through entities. The changes will also clarify that the thin capitalization arm's-length debt test requires consideration of gearing against the underlying assets for interests in any entity. Reducing the ownership threshold to 10% is premised on investors being able to "influence" the financing arrangements for an entity to achieve double gearing, despite not having full control. However, such a bright line test that does not include any consideration of an investor's actual control or relevant influence over the financing of an entity does not seem appropriate. The changes apply from 1 July 2018 and no transitional measures are proposed. It would be reasonable to allow investors whose current financing structures were developed in compliance with the existing rules the benefit of a transitional restructure period. The following measures are all stated to apply from 1 July 2019. Arrangements in existence at the date of the Government's 27 March 2018 announcement can access a seven-year transition period, so the earliest these changes below will apply is from 1 July 2026. Certain additional transitional relief and exemptions from the increased MIT withholding rate are available for investments in certain economic infrastructure. A withholding tax at 30% for distributions that are converted from trading to passive income using a MIT This measure will prevent foreign investors from accessing the 15% MIT final withholding tax rate on active business income. Instead, a withholding tax at the company tax rate (i.e., 30%,) will apply from 1 July 2019.
Importantly for the Real Estate Investment Trust sector, the higher withholding tax will not apply to distributions of cross-staple rent that are sourced from third-party rent. Nor will it apply where only a small proportion of the gross income of the trust relates to cross-staple payments. For investments in "existing economic infrastructure," investments can access transitional relief for 15 years, subject to satisfying unspecified integrity measures. Clarity around these additional integrity measures is needed to allow investors to quantify the effect of the reforms. The Government will also introduce a concession for certain infrastructure projects to encourage the construction of "nationally significant infrastructure" – including productivity enhancing investments. This involves a time-limited retention of the 15% MIT withholding rate, for up to 15 years, for new investment in economic infrastructure assets approved by the Government – subject to satisfaction of as yet unspecified integrity measures. It is not clear whether this will align with the Foreign Investment Review Board's concept of "critical infrastructure." If it doesn't, the Government should explain the discrepancy to foreign investors. Regardless, clarity of these additional integrity measures, and the process that will be used for determining nationally significant infrastructure, is urgently needed. The extent to which enhancements of existing infrastructure are intended to be eligible for the exemption will also need to be confirmed. For example, would the exemption apply only to the enhancement (which seems difficult to implement) or would it cover both the enhancement and the existing infrastructure. Presumably any concerns around overreach of the exemption in the latter case could be managed through the Government approval process. Any limitation of the concession to greenfield infrastructure will also reduce the effectiveness of State Governments' asset recycling initiatives. Unless the concession covers asset recycling, the changes will reduce State Governments' ability to fund critical new infrastructure by reducing foreign investor interest in Australian asset privatization programs. The interest and dividend withholding tax exemptions for foreign pension funds will be limited to interest and dividend income derived from an entity in which the fund has a portfolio-like interest (i.e. < 10% ownership and does not have influence over the entity's key decision-making). The change will apply from 1 July 2019, subject to the seven-year transitional rule for existing arrangements. A legislative framework for the sovereign immunity tax exemption will codify the doctrine of sovereign immunity for foreign government (sovereign) investors. It appears that previous attempts to codify these rules in 2010-11 are being revisited in order to narrow the application of the concession. The exemption, considered by the Government as generous by international standards, will be limited to situations where a sovereign investor has an ownership interest of less than 10% and does not have influence over the entity's key decision making. The exemption will not extend to distributions of "active business income" from trusts (including where active income has been converted to rent through cross-staple payments). The exclusion of the exemption for so called "active business income" will effectively deny immunity for sovereign investors (regardless of their interest) in economic and social infrastructure structure where materially all of the income comprises either distributions sourced from cross-staple payments or distributions from trading trusts. The change will apply from 1 July 2019, subject to the seven-year transitional rules for existing arrangements or where an ATO ruling expires later than the end of the standard transition period. Foreign investor access to the 15% MIT tax rate on rent and capital gains derived by a MIT from agricultural land is seen politically as a competitive advantage over domestic investors. This measure will prevent rent from agricultural land from qualifying as "eligible investment business" income so that the MIT eligibility test will not be met (i.e., the 15% MIT tax rate will not apply). However, unless carefully drafted, the exclusion may also impact resident investors in funds. The change will apply from 1 July 2019, subject to the transitional rules for existing arrangements. The Government announcements will require significant drafting of legislation to implement the proposals. Affected groups will need to undertake impact assessments of the proposals on existing projects, including consideration of the transitional periods, and anticipate any restructures or adjustments which will be required for existing significant investments. Affected groups will need to monitor and become involved in the drafting processes around the many areas to be refined.
Document ID: 2018-5487 |
