On 5 February 2018, the Federal Court’s decision in Resource Capital Fund IV (RCF) shook the Australian private equity (PE) market with a dramatic shift from industry practice.  It is important to note that the decision does not purport to address the legal personality of limited partnerships (LPs) in any jurisdiction – just the tax treatment in Australia under specific rules relating to LPs.

The Court found that the correct taxable entity in respect of gains from a sale of shares in an Australian entity was not the LP but the partners themselves (i.e., the investors in the LP).  Notwithstanding this finding, the Court held that the partners (who were largely comprised of US residents) were entitled to claim tax relief under the relevant tax treaty.

Following this decision, any structure utilising an LP, whether domestic or foreign, will be impacted by the Court’s decision.  We note that Early Stage Venture Capital Limited Partnerships (ESVCLPs) and Venture Capital Limited Partnerships (VCLPs) are not affected.

Broadly, the decision’s findings and implications are as follows:

1. LPs are not taxable entities. This is not consistent with the law, the Australian Taxation Office’s (ATO’s) position, or with current industry practice.  The ATO is likely to appeal to seek to overturn this point or it may choose to exercise its remedial power (which does not require going through Parliament) to ensure the law operates as it was intended.
2. Partners in an LP are taxable. The position that the partners of an LP are jointly liable for the obligations of the LP is neither new nor controversial and is consistent with the law.  However, considered together with item (1), this fact stands to significantly increase the compliance burden of administering a structure that utilises an LP as each partner may be required to lodge an Australian income tax return. 
3. Partners in an LP may be entitled to treaty protection where they are foreign residents. This is not new but has relied on ATO administrative guidelines and specific treaty provisions.
4. Profits from the sale of shares were described as revenue in nature. This means the profits are not entitled to the capital gains tax (CGT) benefits (such as the CGT discount).  While this statement was said in dicta, it is probably the first time such a statement has been made by a judge in a decision.
5. General purpose leases, licences and equipment used in processing operations rather than extraction are not interests in real property for tax purposes. This is significant as it may significantly reduce the number of Australian mining companies that are considered land rich (or “taxable Australian real property”) for CGT purposes.  The ATO is likely to appeal the decision and seek to overturn this point.

Unless the appeal is successful (on point (1) above), the decision would result in offshore investors having to potentially lodge Australian income tax returns and Australians having to include LP income in their tax returns before their distribution.

The danger for the industry is whether the ATO withdraws a tax determination that currently provides concessional treatment to certain foreign LPs (such as Cayman limited partnerships) by treating them as flow through entities instead of taxable entities.