Australia: CGT, tax consolidation changes and RCF IV appeal

March 21, 2018

ATO appeals RCF IV decision

The Federal Commissioner of Taxation has appealed against the decision in the RCF IV case (Resource Capital Fund IV LP v FCT [2018] FCA 41). In that case, the Federal Court had held that the gains derived by two private equity funds, which were Cayman Islands limited partnerships, from the sale of shares in an Australian mining company were not subject to Australian income tax, on the basis that the Australia-US double tax treaty applied in respect of the US tax resident limited partners of the funds to exempt the gains from Australian taxation.

In particular, the Federal Court held that the Cayman Island limited partnerships were not taxable entities under Australian law, notwithstanding that the limited partnerships were generally treated as companies under Australian domestic tax law. The court held that the limited partners of the Cayman Island limited partnerships were the taxable entities (i.e. the parties liable to income tax) and thus were entitled to benefits under Article 7 (Business Profits) of the Australia-US double tax treaty in respect of such gains.

The Federal Court also held that the provisions of Article 13 (Alienation of Real Property) of the treaty did not apply, on the basis that the majority (by value) of the assets of the Australian mining company did not comprise taxable Australia real property assets.

The RCF IV case is important as it confirms the market practice in Australia that treaty resident investors can rely on the relevant tax treaty in respect of gains derived from Australian investments held via limited partnerships (or other fiscally transparent entities) that were established in a non-treaty country. However, the decision did raise some uncertainty as to whether such foreign investors would need to lodge Australian tax returns or otherwise register for Australian tax purposes on the basis that they were taxable entities in Australia.

Foreign investors and fund managers that have investments in Australia should monitor the progress of the commissioner's appeal and any impact that it may have on the tax profile of their Australian investments.

Further restrictions on capital gains tax concessions for foreign restrictions

Further to the removal of capital gains tax (CGT) discount and the introduction of a CGT withholding tax for foreign investors in recent years, the Australian government has now proposed further rules to limit the availability of CGT concessions for foreign investors, which:

Remove the availability of the CGT main residence exemption for foreign residents; and
Amend the foreign resident CGT exemption rules in respect of 'indirect interest Australian real property interest' (IARPI), being certain membership interests in an entity that owns substantial real property assets in Australia. Under the proposed amendments, interests held by the foreign residents associates will also be relevant in determining whether the membership interests held by the foreign resident constitute IARPI.

These measures are to apply from May 9 2017, being the date they were first announced by the Australian government.

Tax consolidation integrity measures

On February 15 2018, the Australian government released draft legislation to close certain loopholes and address uncertainties in the Australian tax consolidation regime. The various amendments are targeted at very specific issues, such as:

Removing the potential double benefit in respect of certain liabilities (that are deductible for tax purposes) of an entity that joins a consolidated group;
Disregarding deferred tax liabilities in the tax cost setting rules for entities that join a consolidated group;
The 'anti-churning rule', which is aimed at preventing tax consolidated groups from resetting the tax cost of an entity's assets that joined the group under certain transactions involving a foreign resident related party; and
Clarification of the treatment of certain assets and liabilities (e.g. financial assets and pre-consolidation intercompany assets) in the exit tax cost setting amount calculations.

These measures have retrospective effect, broadly from the date they were originally announced by the Australian government.

Purchasers and vendors of Australian companies should take into account these new integrity measures when dealing with Australian tax consolidated groups.