Current and emerging tax issues in the new 'normal'

James Momsen | MinterEllison - Annual Partner of the Australian Investment Council

2020 is without doubt a year that will be remembered for having presented more than its fair share of challenges and there is still more than 3 months to go! Whilst private equity sponsors attention was focussed on their existing portfolio assets in response to the immediate economic turmoil generated by the COVID-19 pandemic, as the clouds are now appearing to lift, attention is starting to focus on investment opportunities in the "new normal".

With these themes in mind, it is worth considering how taxation has developed this year – with a number of new issues to consider in deal making, some of which are often overlooked. These issues are outlined as follows:

Control and trading trusts

With respect to fund level issues, the ATO's published but unfinalized position on control and trading trusts is still creating an inherent degree of uncertainty for the industry. The Legal and Tax Committee of the Australian Investment Council have been engaged with the ATO and have made several industry specific submissions addressing key concerns with the ATO's position. It is hoped that the ATO position will be finalised in the near term.

Transaction structuring

The ATO has continued to flag its concerns regarding the use of debt, particularly in cross border transactions with a number of guidance publications on this subject over the last 18 months. For transactors, the taxation outcomes of any proposed capital structure is relevant on all deals, and is brought into specific regulatory focus where FIRB approval is required.

An emerging area of concern for transaction structuring is the use of CGT roll-overs, particularly in multiple step transactions. There are several reviews currently underway, the outcomes and recommendations of which should be monitored.

Landholder duty

Often overlooked by private equity sponsors during transactions is the potential application of landholder duty. Recent changes to stamp duty rules in a number of jurisdictions have expanded the duty payable on acquisitions of 50%+ interests in companies beyond “traditional” land owning companies to apply to operating or services companies.

Now, where a company or unit trust (directly or via subsidiaries) holds interests in fixtures or items fixed to land (e.g. office fit-out or plant and equipment), landholder duty may also be payable. The general threshold value of these items before duty is payable starts at $1 million. Revenue Offices are focused on enforcing these provisions.

Given duty is often payable shortly after a transaction completes, it is critical that funding of it is secured upfront.

Tax due diligence

Tax due diligence remains relevant and understanding the reasons for the effective tax rate of a target should be on the to do list of any transaction planning. Outside the usual areas of tax diligence consideration, some emerging areas of focus in tax due diligence in short to medium term should be:

§ consideration of the eligibility of an investment's historical R&D tax offsets by focussing on how eligible activities have been substantiated and the quality of supporting documentation;

§ assessing whether JobKeeper claims have been properly made given that the ATO has indicated this will be a significant area of focus in the small to medium enterprise market; and

§ ensuring employment taxes are been complied with, particularly where workforces are casual or structured as independent contractors. The risks here can surprisingly become a material item in a short period of time.

Demergers – new opportunities for PE?

Recent ATO guidance on demergers has cast doubt on the ability to carry out demergers in several instances, particularly where such a demerger is to be accompanied by an acquisition or a capital raising. By limiting the circumstances in which the ATO will confer demerger relief, corporates may be forced to turn to other transaction forms to generate shareholder value. In doing so, this may well open the door to new investment opportunities for private equity suitors.

The takeaway

As we enter the final quarter of 2020, the clearer picture of the 'new normal' continues to emerge. Private equity is uniquely positioned to successfully emerge from the turmoil – with record levels of capital ready for deployment. Those sponsors who operate with awareness of the tax issues at fund level, transaction level and at a portfolio level will be best placed to secure that success.

If you are interested in any of the themes and issues covered by this brief article please contact the author for a no obligation discussion on how they relate to your firm.