Q+A-Australia's private-equity tax ruling to test government

MELBOURNE Dec 1 (Reuters) - Australia has ruled that gains from asset sales by private equity firms would be taxed as income, dealing a blow to the nation's $20 billion industry.
The following is an explanation of the tax ruling and its implications.

The tax office ruled that proceeds from a sale of shares in a company bought in a leveraged buyout should be treated as income for the vendor. It specified this would apply also when the vendor is a private equity entity outside Australia which has sold a business in Australia. It also upheld a draft ruling against a holding company structure that used three different countries which it said was set up primarily to avoid tax.

The rulings were made to clarify the tax office's position after it hit U.S. private equity firm TPG [TPG.UL] with a $628 million tax bill in November 2009 on the $1.4 billion profit it made on the sale of department store chain Myer (MYR.AX). The tax office argued TPG's normal business is buying and restructuring companies, then selling them, so any profit made on the sale should be treated as ordinary income and be taxed as such, rather than as a capital gain. TPG argued that any profit on a sale is a capital gain and it should be entitled as a foreign resident to Australia's capital gains tax exemption for foreign investors.

Private equity groups and tax experts have been lobbying the government to clarify in law that profits on private equity sales should be treated as capital gains, on which foreign investors do not pay tax in Australia except in cases involving real estate. The government has said it would review the issue after the tax office issued its final ruling.

"Now the focus clearly shifts to the government," said Yasser El-Ansary, tax counsel at the Institute of Chartered Accountants. "They need to act quickly and decisively to restore confidence for foreign investment in Australia."

In March, then Assistant Treasurer Nick Sherry said the government would consider its policy stance after a final ruling from the tax office. But Sherry was replaced in August and his successor, Bill Shorten, has yet to decide whether to address the issue. "It's likely the government will take a number of months before coming to a position on this issue," El-Ansary said.
The issue could also be thrashed out in Australia's courts, if the tax office presses a case against TPG on the Myer sale.

Private equity interest in Australia could stall. The Australian Private Equity and Venture Capital Association (AVCAL) has warned that the uncertainty over tax has already stalled plans by private equity investors and risks holding back foreign investment in Australia. Planned sales or IPOs have been put on ice until the issue is resolved, industry sources say.

Among the private equity sales in the pipeline are $7 billion worth of media businesses owned by CVC Asia Pacific [CVC.UL] and Kohlberg Kravis Roberts (KKR.N), Pacific Equity Partners' cinema chain Hoyts and bookstore chain REDGroup Retail; and Archer Capital's Ascendia Retail sporting-goods unit.

The pension funds and endowment funds that invest in private equity will also be affected if returns take a hit due to higher tax bills. According to figures from AVCAL, among the 10 largest Australian private equity firms with A$16 billion ($14.7 billion) in funds under management, a little more than half of the funds are from foreign investors.

WHAT ARE THE BROADER IMPLICATIONS OF THE RULING? Australia's government has been trying to position the country as a financial hub in the region, to attract investment flows and financial deals from Hong Kong and Singapore. But industry players and tax experts believe the country's standing as a destination for foreign investment will be put at risk if the government does not legislate to overturn the effect of the tax rulings. "The instability that arose earlier this year surrounding the government's proposed mining tax arrangements certainly dented Australia's reputation abroad. And today's announcements by the tax office will further erode confidence in Australian investment," El-Ansary said. (Editing by Mark Bendeich).reuter.com