Addressing tax risks of stapled structures and limiting foreign investor concessions
Rehashing an earlier press release on 27 March 2018, the Budget reiterates a package of integrity measures directed at stapled structures and similar arrangements. The proposals address the perceived risks to the corporate tax base, due to the potential exploitation of these arrangements and limit concessions currently available to foreign investors.
The key elements of the package and their effective dates are detailed below. For those measures commencing from 1 July 2019, transitional provisions will apply such that if an arrangement is already in place as at 27 March 2018, the measures will not apply to the arrangement until 1 July 2026.
Prevent trading income from being taxed at the MIT withholding tax rate of 15%
It is proposed that, from 1 July 2019, a final withholding tax at the general corporate tax (currently at 30%), rather than the concessional Managed Investment Trust (MIT) withholding tax rate of 15%, be applied to distributions of trading income that has been converted to passive income using a MIT, with the exception of rent derived from third parties.
However, new Government-approved stapled structures for nationally significant infrastructure are eligible for a 15-year exemption from this measure.
Reduce the associate entity threshold under the thin capitalisation rules from 50% to 10%
From 1 July 2018, the thin capitalisation associate entity test will be modified such that any interest of 10% or more in a flow-through entity (ie, partnerships and trusts) will be treated as an associate entity interest, which is aimed at preventing foreign investors from using multi-layered structures to convert trading income into more favourably taxed interest income.
Limit the withholding tax exemption for foreign pension funds on interest and dividends to portfolio investments
From 1 July 2019, any interest and dividend income derived by foreign pension funds from non-portfolio investments (ie, an ownership interest of less than 10% interest) will be subject to non-resident withholding tax. At present, foreign pension funds that are exempt from income tax in their country of residence are exempt from the withholding tax.
Limit the tax exemption for foreign governments to income from portfolio investments
As a general administrative practice, Australia currently provides a limited tax exemption on income derived by foreign governments (including sovereign wealth funds) that are investing in Australia in a non-commercial capacity. This measure proposes to create a legislative framework that will remove the tax exemption from non-portfolio investments from 1 July 2019.
Remove access from agricultural land investments to the MIT withholding tax rate of 15%
This measure proposes to remove rent derived from agricultural land from being qualified as income from an ‘eligible investment business’, which effectively means that such rent will no longer be eligible for the concessional MIT withholding tax rate of 15% from 1 July 2019.
The fact that these measures are all under the common heading ‘Stapled structures – tightening concessions for foreign investors’ can be misleading – the measures go beyond addressing issues associated with stapled structures.
The ‘losers’ of these measures are foreign investors who would otherwise be eligible for the concessional MIT withholding tax rate of 15% on a number of investment fronts. This package may prove to be a tricky move as eroding these tax concessions may discourage foreign investments in Australia, which may have a knock-on effect on the wider economy.
The changes to the thin capitalisation rules may affect existing investors who already have financing structures in place and find themselves denied tax deductions on interest and other debt deductions under the new rules. Given that these rules will come into effect in less than 2 months’ time without any transitional concessions, those affected will need to assess how they may be impacted within a very short time frame and respond accordingly.