Investors face higher tax bills on stapled securities

The federal government is considering doubling the tax rate applied to more than $199 billion worth of so-called stapled structures, in a move that experts say could scare off foreign investors.

Separate securities, such as a share in a company and a unit in a trust, can be stapled together to create a tax-advantaged financial instrument that has long been used in the property and infrastructure sectors (see Helpful Resources > Investments > Why Stapled Securities for more information on these types of investments).

This structure is particularly attractive to foreign investors because, when combined with rules for managed investment trusts, it allows tax to be paid at 15 per cent or lower. That compares to the normal company tax rate of 30 per cent.

But the government and Australian Taxation Office are worried that stapled structures have been adopted beyond the traditional property and infrastructure sectors by entities seeking to convert active business income into tax-advantaged passive income.

The Tax Office issued a taxpayer alert in February. The revenue authority said it had seen more than $10 billion in non-compliant structures over the past 12 to 18 months, with $300 million estimated to be in dispute. ATO officials were “discouraging these type of arrangements”, which would be subject to increased scrutiny, including audits and potential litigation.

Now the government has flagged a policy change. In a discussion paper released on Friday 31st March, Treasury set out options for “removing the tax advantages of stapled arrangements”. Treasurer Scott Morrison may use the May federal budget to announce any changes.

Beware

Allens tax practice leader Martin Fry said he was worried about the mixed signals being sent to foreign investors.

“The government needs to exercise care and get the narrative right,” he said.

“On the one hand, Australia has been at pains to attract investment.

But on the other, uncertainty is emerging over structures through which toll roads, ports, power assets and shopping centres have been held for many years without being viewed as possibly tax aggressive.

A stable approach to policy change would see existing structures carved out of any law change.”

The use of stapled structures has spread beyond infrastructure and property to agriculture, renewables, mining and technology. Assets such as royalty streams and intellectual property are being moved into passive structures.

The Treasury paper says one option for change would be to treat stapled entities as consolidated for tax purposes, which would see them taxed entirely at 30 per cent. Another option would achieve the same end by treating the trust element of a structure as if it were a company.

But there could be carve-outs or protections for managed investment trusts, real estate investment trusts and critical infrastructure, the paper also suggests.

The Turnbull government has reaffirmed its commitment to cutting the corporate tax rate and is likely to continue to pursue “integrity” measures to provide assurances that tax avoidance is under control.

Stapled structures have come to the attention of the ATO because their tax arrangements have been included in the criteria for approval by the Foreign Investment Review Board.

$199 billion

According to the Treasury paper, there were six listed staples in Australia in 2000. This has grown to more than 60 and a range of unlisted staples has also emerged. As of December 2016, listed staples accounted for approximately $199 billion in ASX market capitalisation, up from $149 billion two years earlier.

“The re-characterising of trading income into a lower taxed passive income flow reduces overall tax revenue and presents a risk to the integrity of the corporate tax base,” the paper says.

“This undermines the ability of the government to funds its activities and deliver services to the community”.

Australian real estate investment trusts and infrastructure funds, by value and number, are largely stapled. Stapled structures are used by almost 90 per cent of infrastructure funds.

University of Melbourne finance professor Kevin Davis has previously questioned the basis for the tax structures given they have been banned in most developed countries.

Article extracted from AFR article of same title by Joanne Mather