Contributed by Scott Heezen, Partner, Mark Upfold, Partner and Anthony Mourginos, Solicitor, King & Wood Mallesons
A new consultation paper signals a potentially dramatic change to the income tax treatment of stapled structures, with wide ramifications for the Australian infrastructure sector. The government says it is concerned that stapled structures, which have become a common investment structure (ironically sponsored by a number of state and Commonwealth privatisations), are artificially re-characterising active trading income as “rent”, thereby attracting a concessional tax outcome.
On 24 March 2017, the Australian Government released its Stapled Structure Consultation Paper (Consultation Paper) seeking submissions on potential policy options to address issues that may arise in relation to stapled structures, the taxation of real property investments and other arrangements to re-characterise trading income.
The Consultation Paper follows the release of Taxpayer Alert TA 2017/1 on 31 January 2017, which sets out the ATO’s concerns with a variety of arrangements that, in the words of the Commissioner, “… attempt to fragment integrated trading businesses in order to re-characterise trading income into more favourably taxed passive income”. On its own, this alert has been causing a number of issues for investors, including those seeking FIRB approval in relation to existing and new investments.
While the Consultation Paper examines some of the issues raised in the TA 2017/1, it is seeking to undertake a wider examination of the use and consequences of such structures and how Australia may differ from other jurisdictions. It sets out some broad policy options that could be considered to address the perceived problems as well as possible implications for the Australian economy.
What does it mean?
It is clear that Australian infrastructure is now at a crossroads. Stapled structures have been used for decades and more recently on privatisation transactions and in this regard have helped facilitate delivery of significant upfront proceeds to the state vendors. Led by the NSW Government’s recycling initiative, the Commonwealth has endorsed the process by providing the states with capital contributions to assist their infrastructure spending programs and therefore endorsing the success. Over recent years, the states have been key drivers and facilitators of these structures given that they are the main beneficiary. Indeed, some governments have used their own staples on transactions where they have a medium or long-term objective of selling down or monetising their own investment in infrastructure. State and Commonwealth departments have also benefited from the use of staples in their own investments in a number of contexts.
Although the removal of the tax advantages offered to stapled structures may increase the cost of capital for particular arrangements, Treasury is of the opinion that this will “reduce distortions to investment decisions and improve competitive neutrality” (ie entities and industry sectors previously unable to benefit from the re-characterisation of active income may be better able to compete on price). This arguably ignores the consequences for the states as well as resident and non-resident investors looking to maximise their return on a selldown of existing project investments.
Equally, changing the taxation treatment of stapled structures could be a disincentive for foreign investment in sectors such as agriculture, tourism, renewables as well as infrastructure (where the government has, in recent years, focussed on attracting investment). These sectors have commonly utilised stapled structures, and economics of an increased recovery of taxes following a change in law will need to be carefully balanced against the risk of loss of investment to other countries with more attractive or effective investment regimes.
Furthermore, although not ruled out in the Consultation Paper, it appears at this stage unlikely that any permanent “grandfathering” of existing structures would be permitted, with Treasury preferring to implement transitional arrangements to ensure all stapled entities are treated equally from a taxation perspective and have sufficient time to ensure compliance with any new laws. Australian infrastructure has been an attractive destination for international pension funds, in part, because of Australia’s good reputation for regulatory risk. Retrospectivity to require (possibly) the unwinding (and consequential tax profile changes) of existing structures will impact negatively on the perception of Australia as a predictable and safe market. This will be a key concern for many investors in projects which have an investment term of up to 99 years if any change in law is not clearly targeted. It also makes for a difficult conversation with foreign investors when trying to explain the policy rationale for changing a tax law that applies to structures that were often specifically put together at the behest of and for the direct and indirect benefit of Commonwealth and state government sponsors.
While there has been a clear proliferation in use in recent years and we can understand some of the concerns that have been raised by Treasury and the ATO in particular contexts, we can’t help but think the policy setting here is one where the Commonwealth should seriously consider permitting stapled structures where there is clearly a flow on effect of enabling higher levels of funding and financing for new infrastructure projects rather than creating further uncertainty through broad-brushed integrity measures or blanket restrictions on use. It is also important that a clear position is reached on the application of the provisions to new as well as existing arrangements as soon as possible.
Consequences for A-REITs
The news is better for Australian real estate investment trusts (A-REITs) with the Consultation Paper noting that most jurisdictions provide for concessionary treatment of REITs and in many cases allow for greater levels of non-passive income. It raises the possibility of a specific A-REIT regime or alternatively greater specificity regarding acceptable and non-acceptable fragmentation structures in the REIT context within the existing law. A clarification of the existing rules in ITAA 1936 Div 6C is to be welcomed and any such review should consider current issues such as the classification of student accommodation, hotels as well as increased safe harbours for non-rental income. The ability to allow certain associated development activities in a non-stapled context without jeopardising flow through treatment should also be examined.