Posted by John, November 18th, 2009 - under Private equity funds, Tax, Tax avoidance, Tax havens, Tax Office.

Tags: ATO, Australian Tax Office

Private equity funds are the bottom feeders of capital. They buy up what they judge to be undervalued companies, take a chainsaw to jobs and costs to increase the seeming value of the company in the short term and then flog the entity off at a large gain a little later.

They themselves add no real value to entities or the productive processes of capitalism. They effectively expropriate from other more traditional expropriators the surplus we create.

That’s why Rupert Murdoch and his Australian newspaper hate them. For example a recent editorial in The Australian said:

By their nature, they have a strong propensity for short-termism, tricky accounting practices, asset stripping … and tax minimisation. Often nominally based in tax havens, such companies have no loyalties to any nation, any industry, any established company or any workforce, no matter how productive and experienced. by focusing on the bottom line they often distort traditional productive capitalism.

They were, before the global financial crisis, also often heavily debt funded to wipe out any income for tax purposes while the vulture capitalists held the investment, readying it for re-sale.

It is no surprise then that these Vikings of capital care little for tax or indeed other niceties.

Take Texas Pacific Group. TPG, as part of a consortium, bought Myer in 2006. In 2009, replete with Jennifer Hawkins’ advertising, it floated Myer to the public.

TPG made almost $1.5 billion profit on the deal last week. Within a few days the money was out of Australia.

The Tax Office has claimed that there was a $452 million tax debt and has also imposed a tax avoidance penalty of $226 million.

Let me explain in fairly simple and simplistic terms how this came about. I want to stress I do not have any ‘inside’ knowledge of the arrangements and know only of the ‘facts’ from newspaper reports.

In 2006 Australia changed its capital gains tax laws. (I want to stress I am talking about capital gains tax, not ordinary income like salary or wages or interest or business income).

The change meant (with some big exceptions) that non-residents like TPG would no longer be subject to capital gains tax. The logic was that these non-residents would be taxed on any capital gains in their home country. Of course structuring the ownership through tax havens may make a mockery of that.

Most capital exporting nations have such a rule and although Australia is a capital importing nation the argument goes that we will become a capital exporting nation soon enough and so we should adjust our international tax regimes (including the taxation of foreign residents’ capital gains) accordingly.

We did.

Now there is one problem with this analysis. TPG’s profits are not capital gains.

Private equity groups like TPG are in the business of making profits from their pillaging of undervalued companies. This makes the gain income. So the exemption doesn’t apply and the gain should be taxed as ordinary income.

Let me try to use an analogy. The gain on your home, something you hold for decades, is a capital gain.

But if you buy a house, with the intention of doing it up and then flogging it off for a profit, that gain is income, not capital. You are in the business of buying, improving and selling such houses, so any gain is business income.

In the Myer case, TPG ownership seemingly starts with the Cayman Islands ( a tax haven until 29 October this year, although a leopard never really changes its spots even if there are Tax Information Exchange Agreements in place) then Luxembourg and the Netherlands and onto Australia. Of course hiding behind the Cayman Islands stand companies in the US.

So you have a conga line of countries through which ownership passes to stop authorities like the ATO pursuing the money through these bank and tax secrecy countries and preventing the home country (such as the US) imposing tax on the receipts (or so I would guess).

Why route an investment from the US into Australia via the Cayman Islands, Luxembourg and the Netherlands? Why not do it directly? Avoiding tax is the answer, I suspect.

The Netherlands gives a veneer of respectability to the arrangement but it is respectability in name and appearance only. Because of its porous and flow through tax regimes, and the fact it is a developed country with double tax agreements with most major economies it is a favoured destination for tax avoiders. Think James Hardy for example.

A few days after the Myer float the ATO got an injunction freezing the accounts the TPG money from the Myer sale went into. They were too late. There was only $45 left.

Now, while the ATO may well get a debt judgement against the companies involved, the ATO in all likelihood will not be able to enforce it in foreign jurisdictions. As long as TPG never comes back to Australia they might have ‘avoided’ tax here.

A criminal investigation and pursuit of the money would be a different matter.

Why was the ATO so slow?

Over the last five or so years the Tax Office has run down its specialist international area so it is only a shell of its former self. International expertise, both technical and compliance based, has plummeted.

The Myer float has been in the public arena for at least four months.

The argument that the gains are on revenue account, not capital account, is not rocket science.

Indeed, from memory, my ATO International New Measures Team advised Treasury of this very point in discussions before the draft Bill exempting foreign residents from capital gains tax was finalised and passed. (The Explanatory Memorandum on the Bill may make the same point. I would have to check.)

Again from memory we pushed within the ATO for a ruling or similar on the issue. Clarification of the exemption was also, I believe, raised at a number of consultative forums.

But the ATO is so starved of technical experts and the workload is so great that it has to prioritise priorities, and not unreasonably expects new law to be able to tell tax experts the bleeding obvious – business income is not capital gains.

So any decent tax adviser (and TPG would have had some very decent tax advisers) would have known of the income/capital risk.

They might also have told TPG that even if they could convince a court this was a capital gain, they might still have to pay tax on any capital gain associated with TPG having an office in Australia (which they did). And the advice would have presumably encompassed the real possibility that the general anti-avoidance provisions would scuttle the arrangement.

These real tax risks may perhaps explain the apparent haste in withdrawing the money from Australia and putting it seemingly out of the reach of Australian tax authorities.

This doesn’t mean the ATO will win. It may for example have to show the gains are, under the double tax agreement with the Netherlands, business profits associated with a permanent establishment (e.g. an office) in Australia. And using Part IVA, the general anti-avoidance provision, is always a risk.

TPG claims it has not avoided any Australian tax. If they are so confident that this is the case why not voluntarily remit half the tax and penalties in dispute back to Australia’ pending resolution of the dispute? Come on TPG, show us your bona fides.

It is not surprising that the venture capitalist association and various tax commentators have painted TPG as an innocent victim of a rapacious ATO. This is bunkum. They know the exemption doesn’t apply to business income, although they might wish it did.

Now it is true that some in the ATO hate the international tax reforms of the last seven years and see them as an affront to any sense of tax equity.

These officers have yet to learn that, to think within bourgeois parliamentary terms, these are policy decisions of and for Government, not the ATO. The Office’s sole ‘policy’ role these days is to advise on administrative aspects of policy development, not the policy itself.

Having said that (and it really is a story for another day) the actions of the ATO in trying to prevent money leaving the country and pursuing this tax debt against TPG are perfectly legitimate. Late, but legitimate.

The ATO is attempting to enforce the law as it stands, not as some commentators and tax advisers would want it to be.

Private equity funds add no real value to Australian society. And as TPG shows, they may attempt to avoid tax altogether.

Where is the political outrage from the Government and Opposition about this pillage of our society? Silence is all I have heard to date.

An enquiry into the impact of these vultures on Australian society is overdue.

For the last month Australian politics has been racked by debates about a couple of hundred refugees trying to come to Australia.

Yet when one private equity fund allegedly scarpers with $452 million of our tax money, our politicians are silent.

If the choice is between refugees or rich revenue refuseniks, I’ll take the refugees and their productive possibilities any day.

As a former Assistant Commissioner in International in the ATO, I have written a number of articles on tax on this site.