Australia: Stapled Structure Changes Announced.
Legal News & Analysis - Asia Pacific - Australia - Tax
2 April, 2018
Treasurer announces major changes to taxation of stapled structures and foreign investor tax concessions, with grandfathering
What you need to know
Yesterday the Government released its package of measures to address tax integrity risks associated with stapled structures and to limit broader tax concessions available to foreign investors (Package).
The Package contains a number of major changes to the tax treatment of foreign investors into Australian assets that will alter the way in which many investments are structured.
MIT concession changes
Significant limits will be placed on Managed Investment Trust (MIT) concessions that are currently very widely used involving stapled structures for non-resident investors:
- From 1 July 2019, integrity measures will prevent stapled structures from being used to enable business income to be taxed at the 15% MIT tax rate and, in addition, investment in agricultural land will cease to be a qualifying MIT activity;
- Existing (pre-27 March 2018) stapled structures will be quarantined from these new rules for 7 years or, in the case of infrastructure staples, for 15 years; and
- The Government will still allow new staples to access the concessions for qualifying infrastructure investments, but only where specific conditions (to be announced) are met.
Thin capitalisation changes
With effect from 1 July 2018, thin capitalisation rules will restrict interest deductions when "double gearing" structures are used – that is, where interest bearing debt is introduced in multiple "flow through entities" (eg trusts and partnerships). From that date, the thin capitalisation rules will apply where a flow though entity holds more than a 10% interest in another flow through entity.
New limits on withholding tax exemptions for foreign pension funds
From 1 July 2019, foreign pension funds will only be exempt from Australian dividend or interest withholding tax where they hold a less than 10% interest in the paying entity (currently, there is no limit on the exemption). This measure may materially increase the effective Australian tax rate for foreign pension fund investors in Australian assets.
Further limits on the sovereign immunity exemption
The tax exemption for foreign sovereign investors (including sovereign wealth funds) will be further limited to portfolio investments (ie where the sovereign holds less than 10% of the investee and does not otherwise influence the key decision making of the investee).
Background - Stapled Structures Review
Stapled structures initially became common in the Australian property sector following the introduction of the "public trading trust rules" in the 1980s. These rules operate to tax certain widely held trusts as companies unless the trust carries on wholly passive investment activities (in which case the trust can still be characterised as a "flow-through" trust for tax purposes).
Under a stapled structure, investors hold units in a trust that carries on wholly passive activities and (generally) shares in a company that carries on active business activities, with the two securities "stapled" together such that they cannot be bought or sold separately. In this way, the tax "flow-through" status of the trust may be preserved.
Prior to the introduction of the MIT rules, stapled structures were largely limited to the property sector, to ensure that various non-passive activities of property trusts (eg commercial car parks associated with commercial property) were held in a separate vehicle so as not to disqualify the trust from flow-through tax treatment. Generally, foreign investors in these entities were still taxed in Australia at their marginal tax rates on income derived through the trust.
However, as a result of the introduction of the MIT regime, foreign investors in stapled businesses were no longer effectively subject to tax at the corporate tax rate - if the trust side of the staple was a MIT, tax was generally withheld on rental income at 15 per cent. As a result, stapled structures started to be used to "convert" active business income into passive rental income, by having passive land assets held in a MIT and leased to an operating company. The taxable income of the operating company would be reduced by rental payments to the MIT and the rental payments to the MIT were eligible for the 15% MIT withholding tax rate.
In response to these structures, the ATO released Taxpayer Alert 2017/1 and the Government subsequently announced a complete review to address the concerns raised by the ATO in TA 2017/1.
Other Foreign Investor Tax Concessions
A range of other tax concessions are available to foreign investors which are not available to domestic investors. These include:
- An ability to use tax deductible "upstream debt" (ie debt borrowed by the investor into a flow-through trust) to convert Australian taxable income of the investor otherwise taxed at the corporate tax rate into concessionally taxed interest income. This structure is generally available where the investor's interest in the Australian flow-through trust is a "non-associate" interest (generally, less than 40%). In some cases "upstream debt" could be borrowed through multiple tiers of flow-through vehicles, progressively reducing the Australian taxable income at each level.
- A complete withholding tax exemption for interest and dividend income of foreign pension funds, regardless of their percentage interest in the investment vehicle.
- Sovereign immunity exemptions for certain foreign government ("sovereign") investors on income from "non-commercial" investments.
These concessions were seen as giving rise to a competitive imbalance by creating tax incentives favouring certain foreign investors over other foreign investors and domestic investors to whom these concessions are not available.
Stapled Structure Measures
The Package contains measures designed to address the tax integrity risks posed by stapled structures described above.
In particular, the law will be amended to apply a final withholding tax at the corporate tax rate for distributions derived from trading income that has been converted to passive income using a MIT.
As a result, "cross-staple payments", such as rent or interest, made by the company side of the staple to the trust side of the staple, will essentially be recharacterised and subject to withholding tax at the (currently 30%) corporate tax rate.
This is subject to an exemption from the measures for new, Government-approved infrastructure assets, which will continue to enjoy the concessional tax treatment currently available to stapled structures for 15 years. This exemption is designed to support the development of nationally significant infrastructure assets.
In addition, the Package will exclude agricultural land from being an eligible asset for a MIT.
The other tax concessions available to foreign investors have been dealt with as follows:
To deal with the "upstream debt" issue, the thin capitalisation rules will be amended to prevent foreign investors from using upstream tax deductible debt where they have a non-portfolio interest (10% or more) in the underlying investment vehicle.
The foreign pension fund withholding tax exemption for interest and dividends will not be available where the foreign pension fund has a non-portfolio interest in the payer of the interest or dividends.
In relation to sovereign immunity, the law will be amended to create a comprehensive legislative framework for the immunity and will also limit the exemption to passive income from portfolio investments.
Overall, the effect of these measures is to exclude foreign investors from these tax concessions where they hold an interest of 10% or more in the investment vehicles.
These changes (except the thin capitalisation changes), will take effect from 1 July 2019. The thin capitalisation changes will take effect from 1 July 2018.
Transitional arrangements of seven years (for existing ordinary business staples) and 15 years (for existing infrastructure staples) have been included for the majority of the Package (other than the thin capitalisation changes). This will limit the immediate impact of the measures announced in the
Package for existing assets.
Treasury will consult separately on the conditions stapled entities must comply with to access the transitional arrangements.
For further information, please contact:
Peter McCullough, Partner, Ashurst