As many of our clients would be aware, stapled structures involving a flow-through trust and a corporate tax entity have been commonplace in the Australian market for decades. They are prevalent in the property industry, amongst infrastructure asset operators, in private equity investment structures and any other industry where a passive asset is used in connection with an operating business.
Despite their prevalence and despite having known about them (and in fact explicitly or implicitly approved their use) for decades, the Australian Taxation Office (ATO) has recently publicly announced in Taxpayer Alert TA 2017/1 that it will closely review stapled structures. Thankfully, widely held real estate investment trusts with third party tenants are safe (at least for the moment).
The law on the taxation of trusts has evolved rapidly in the last decade or so, thanks largely to the introduction of a number of structures with special tax characteristics and the limited taxation of non-residents. However, despite this evolution, they remain some of the most archaic and poorly understand parts of Australian tax law.
It is imperative to understand that none of the concerns being raised by the ATO are new. Indeed, many of our clients would have been well advised on the application of the tax law, related risks and the potential for differences in views between the regulator and industry. However, the public alert is concerning as it contemplates increased scrutiny of stapled structures that are commonly used and accepted, it urges increased engagement with the ATO and is seemingly aimed at discouraging the use of such structures.
The perceived abuse is that stapled structures are being used to divide an integrated business into two, and thereby avoid tax.
Take the simple example of a farm. The farm’s business can be divided into a passive property holding business and an active farm operations business. Put the property holding business into a trust; the farm operations into a company. The trust charges the company a rent. The potential tax effects include:
- The company has gone from tax-paying to being in a tax neutral or loss position. Taken to an extreme, the rental charge can strip the company of all profits;
- The trust is able to flow cash through to beneficiaries (particularly non-resident beneficiaries) tax-free or at a lower rate of tax; and
- Non-resident shareholders of the company may be able to sell the shares in the company for no tax, whereas it could have been subject to tax as an integrated business.
The ATO is also concerned that these structures are being set-up for the primary purpose of satisfying the Managed Investment Trust (MIT) rules (to obtain a lower tax rate for non-residents). Taking the above example, the property holding business would be held via a MIT. If the two businesses were operated under a single entity, the business may not be eligible for concessional taxation under the MIT rules.
The structures that will come under scrutiny will have the following key features:
- Entities are stapled, either in legal form or economically (including, practically, investors would always deal with the entities together);
- Cross-charge includes interest, royalties and rent;
- Restructures to move to a stapled structure (these are likely to be particularly frowned upon); and
- Acquisitions where previous owner/s held as an integrated business (these are likely to be treated with some suspicion).
How significant is the risk?
The risk has not suddenly increased. The ATO has not only been aware of the prevalence of these structures, it has also been active in examining this issue, particularly in the context of loans within stapled structures. In our experience, the ATO’s success rate in challenging such arrangements has been low and we are not aware of any that have been taken to court. Further, clients implementing such structures would have been advised on the risks associated with them. Although it is unclear where the ATO will ultimately draw the line, it is safe to say that restructures of existing structures or restructures as part of an acquisition are likely to face increased scrutiny.
Other related areas of concern
The ATO has also stated that it will look at the control element of dual trust structures and whether the requirements for MITs are satisfied.
What should you do?
Review your advice The first step for clients who have implemented stapled trust structures is to dust off the tax advice received and make sure it appropriately covers the tax risks associated with stapled structures and intra-group charges. If the advice does not do this, it is advisable to have the advice updated.
Consider anti-avoidance rules In our experience, advice in this area often omits overt consideration of the general anti-avoidance provisions, focussing instead on specific avoidance provisions. This will be the area which will be most important for the ATO given the yet untested 2013 changes to the anti-avoidance rules which make them easier to apply for the ATO.
Engage The ATO, as has been its mantra since Chris Jordan became Commissioner, is seeking early and active engagement with taxpayers. One of the outcomes it will want from the tax alert is to have those seeking to implement stapled structures seek advice from the ATO. Consider the merits of doing this carefully.
Evaluate Ideally, the ATO would see a trend to fewer stapled structures being implemented. As has always been the case, the use of any structure is a matter of weighing up commercial, legal, financial and tax considerations. The use of stapled structures will be more controversial where there is a restructure (either of an existing structure or a vendor structure) to move to a stapled structure. Ultimately, good commercial, legal and financial reasons will act as a defence to ATO action.