Tuesday, August 23rd, 2011 - Machel Advisory Services
Detrimental outcome for Managed Investment Trusts and venture capital conduit vehicles

In a recently released interpretative decision, the Australian Taxation Office (“ATO”) has adopted a strict interpretation of the black letter of the law, which effectively narrows a concession the Australian government introduced for Managed Investment Trusts (“MITs”). The concession was a big win for MITs given that it provided them with certainty on the nature of divestment gains for certain assets where MITs opt-in for capital treatment of those assets (i.e. the gains become subject to the Australian capital gains tax (“CGT”) regime). Previously, MITs had to rely on general law principles to ascertain whether an asset is either on capital account or revenue account. Whilst a reasonable determination could subjectively be reached, there was no certainty as to whether the ATO may challenge the position taken by the MIT. The attractiveness for an asset to be on capital account is: 1) only part of the divestment gain may be subject to tax for domestic investors (i.e. the CGT discount may apply) and 2) capital gains will generally be tax free for offshore investors.

The ATO has ruled that where a MIT has an indirect interest in investee companies through a venture capital limited partnership (“VCLP”), on divestment by way of share sale, the shares will not be automatically granted capital treatment. Instead, the MIT will need to make an assessment on whether the shares are on capital account or revenue account according to general law principles. It should be noted that if the MIT held the shares directly, as opposed to through a VCLP, then the automatic capital treatment would have applied if the MIT has opted-in the capital treatment concessional regime.

The conclusion reached by the ATO in this instance differs from an earlier interpretative decision made in relation to superannuation funds. The contrary view was that superannuation funds could treat their indirect (share) interest, acquired through a VCLP, in investee companies on capital account. Whilst the same premise, that is CGT is the primary tax code, applies to both MITs and superannuation funds, the concession is limited to a handful of assets for a MIT. A share owned by a MIT would constitute an eligible asset for the capital treatment concession whereas an interest in a share would not qualify. This begs the question of whether this is a drafting oversight or an intended consequence.

Whilst the interpretative decision relates to a VCLP as an interposed entity, it is expected that the interpretative decision will have wider implications with equal application to other interposed transparent entities such as Australian foreign hybrids (limited liability company (“LLC”), limited partnership (“LP”) and limited liability partnership (“LLP”)) and early stage venture capital limited partnership (to a lesser extent). It is common practice for Australian fund managers to use LLC, LP and/or LLP as part of their structure for their offshore investments. Australian fund managers have taken comfort that they are shielded by the capital treatment concession. However, the current stance by the ATO will throw into jeopardy some of the offshore divestments that Australian fund managers have undertaken in recent times. It is critical that the tax legislature be amended to broaden the MIT’s asset pool eligible for the capital treatment concession and in the meantime the ATO should not seek to actively police its aforementioned view.

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Machel Advisory Services is a boutique advisory firm with focus on the funds management and private equity sector. If you want to further discuss this article, please email us at [email protected]



Yanese Chellapen
P: +613 8635 1987
W: www.macheladvisory.com.au

Keywords

Managed investment trust, VCLP, Australian foreign hybrid, ATO, funds management, Australian funds managers, Australian funds management, capital gains tax

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