Scott Farrell, Brendon Lamers, Minh Dao and Matt Ervin review the implications of the Government's stapled structures detailed integrity package.
On 27 March 2018, Treasury released details of new integrity measures to address the sustainability and tax integrity risks posed by stapled structures and the broader concessions available to foreign investors. These measures follow the release of Taxpayer Alert 2017/1 and an extensive consultation process relating to the potential tax benefits associated with stapled structures.
The measures announced are intended to ensure that Australia’s tax system is fair and competitive to both local and foreign investors. The current policy settings are seen to allow foreign investors to achieve effective tax rates of between 0 and 15 percent and so creating a tax bias in favour of these investors and in certain asset classes. Further details will be required in order to assess whether this package achieves its aim of creating a level playing field between local and foreign investors.
These structures will not be required to restructure on a go-forward basis. However, these changes provide the opportunity for groups to give consideration to whether a stapled structure continues to be the most appropriate and efficient investment structure going forward. Once the draft legislation is available, consideration should be given to the preferred future investment structure and the potential costs and benefits of transitioning to that structure in the medium term.
Managed investment trusts (MIT) income derived from cross staple rental payments, cross staple payments made under some financial arrangements such as total return swaps, or where the MIT receives a distribution from a trading trust will be subject to withholding tax at the company tax rate of 30 percent.
This is to ensure that MITs are not able to convert active income into rent and benefit from the lower MIT withholding tax rate. However, a ‘small’ proportion of gross income from cross staple arrangements will be permitted.
MITs that have a non-controlling investment into a single trading trust (including some PPP and renewable investments) may now be subject to a 30 percent rate of tax.
A concession is to be introduced to encourage “construction of nationally significant infrastructure” by allowing “new investment in economic infrastructure assets” approved by the Federal Government to qualify for the 15 percent MIT withholding tax rate for a period of 15 years. It is not clear whether this concession is limited to construction of new infrastructure assets only or if it could apply to a government recycling of its capital investments through the sale of a mature infrastructure asset in order to fund the construction of new infrastructure. After the 15 year period, a 30 percent tax rate will apply.
Treasury will consult separately on the conditions stapled entities must comply with to access the infrastructure concession (for example, stronger integrity rules may be needed to protect against aggressive cross staple pricing).
Given that new infrastructure projects involve significant capital investment, tax losses can be realised during the initial period of the investment. This means that, in practice, infrastructure projects could enjoy the reduced MIT withholding tax rates for considerably shorter period of time.
Traditional staples in the commercial and retail property sector largely earn income from third party rent and do not give rise to integrity concerns. This is due to the fact that stapled real estate investment trusts (REIT) investing in property in these sectors are not considered to be converting active income into passive income. Treasury have also accepted industry representations that a separate REIT regime is not required.
Certain property asset classes have involved a stapled structure that has a real estate asset being leased to a stapled company that operates the asset. This may include student accommodation, hotels and aged care facilities. Such arrangements will be subject to the restrictions outlined below. However, it would appear that if such assets are leased to a third party operator, the arrangements would fall outside Treasury's announcement.
The thin capitalisation ‘associate entity test’ will be lowered from 50 to 10 percent for interests in flow-through entities such as trusts and partnerships. This measure is intended to prevent the potential tax benefits available to foreign residents from ‘double gearing’, by grouping ‘associate entities’ when working out the thin capitalisation limits. These measures will apply from 1 July 2018.
The withholding tax exemption for foreign pension funds from interest and dividend withholding tax will be limited to portfolio-like investments (i.e. an ownership interest of less than 10 percent) and no influence over the entity’s key decision-making.
The sovereign immunity tax exemption will be limited to situations where sovereign investors have an ownership interest of less than 10 percent and do not have influence over the entity’s key decision making. Treasury has also proposed a legislative framework for the sovereign immunity exemption, in contrast to the current regime which is applied on a case-by-case basis but is not limited to investments of less than 10 percent.
Rent from agricultural land will no longer qualify as eligible investment business income.
The above announcements (apart from the proposed thin capitalisation changes) will apply from 1 July 2019 but there will be a seven year transitional period will apply for arrangements in place or committed to prior to the announcement. This means the earliest date on which these measures apply is 1 July 2026.
To the extent that a sovereign immunity ruling extends beyond the seven year transitional period (effectively meaning that it has in excess of eight years remaining), the transitional period will be extended. For ‘existing economic infrastructure’ a 15 year transition period applies.
These questions are ones that we will be endeavouring to resolve through further consultation with Treasury over coming months.