The Australian Taxation Office (ATO) released a controversial Taxpayer Alert, TA 2017/1 on 31 January 2017. The Taxpayer Alert relates to structures involving both a company (taxed at the corporate rate) and a trust (taxed as a flow through vehicle). The ATO has particularly highlighted structures involving a managed investment trust (MIT) with overseas investors.
The Taxpayer Alert is likely to affect investors in numerous asset classes, including infrastructure and renewables.
Investors need to carefully consider whether their investments are likely to fall within the (very broad) parameters identified by the ATO and should develop a strategy for engaging with the ATO.
Which structures are the ATO concerned about?
The ATO is concerned about “rental staples” (and similar structures where the entities are not stapled). This structure involves the following:
- The trust owns land or a fixture on land.
- The company enters into one or more agreements with a trust to lease or otherwise access the selected assets to enable the company to operate its business. The company claims a tax deduction for rental payments to the trust.
- The nature of the business is such that the transactions to divide the business in this manner are not transactions that third parties acting at arm's length would usually enter into, and it is often also the case that the business is not one capable of division in any commercially meaningful way.
Further, the ATO has also identified these structures as being of concern:
- Finance staples: Broadly, where the company has the operating business, carries less than the normal expected level of equity, and borrows from the trust. The trust funds the loan through capital invested in the trust by the beneficiaries. The company claims a deduction for interest payments and the interest income is distributed by the trust to investors.
- Synthetic equity staples: The company pays profit or turnover equivalent amounts to the trust and claims a deduction. The trust is usually an MIT and distributes the income at concessional tax rates to overseas investors.
- Royalty staples: The trust holds assets such as intellectual property, mining tenements, industrial equipment, or other assets of a business that produce a royalty. The company pays a royalty to the trust and claims a deduction. The distributions from trust to non-resident investors are subject to royalty withholding tax (usually at a rate capped under a double tax treaty).
How will the ATO challenge them?
The ATO may challenge the structures under one or more of the following methods:
- Questioning whether the trust is actually a flow through vehicle or MIT. (That is, seeking to tax the trust as a company under Division 6C of the Income Tax Assessment Act 1936.)
- Seeking to characterise debt instruments as equity interests under the debt/equity rules.
- Seeking to apply the anti-avoidance provisions in Part IVA of the 1936 Act.
Which structures should still be OK?
- Real estate investment trusts, where the trust rents a building to third parties and the company provides operational services.
- Real estate transactions, where the trust rents a building to the company, which licences the land to third parties.
- Privatised assets, where the business are “effectively land (and land improvement) based or heavily reliant on particular land holdings and related improvements” (However, the ATO will indicate guidance on these transactions and will also provide further detail on a transaction by transaction basis).
For information about the implications of this development for your business, please contact one of our Australian Tax partners (see below).