• Tax treatment of investors into PPPs

    This chapter sets out the tax implications for the investors into social PPPs.

    How is the investment structured?

    Typically, the consortium members will subscribe for equity in a project holding trust, which will in turn subscribe for equity in Project trust. Some of the consortium members may initially invest into Project trust for a purpose of making a profit from the sale of their interests within a few years after the end of the D&C phase. Other investors will have longer time horizons.

    These investors also may be non-residents. The non-residents typically would hold their investment through an Australian resident holding trust.

    In some structures, the equity in Finance co will be held by a charitable trust via a holding company.

    This diagram depicts the transactions that occur during the operations and maintenance stage of a PPP pertinent to GST.

    Tax treatment of the investment

    This part will examine the tax treatment of the investors into the social PPP.

    The charity

    In the event that Finance hold co makes a profit, there may be a distribution to the charity. A discussion on the taxation arrangements applying to charities is out of scope of this framework, and is dealt with in the relevant sections of our website.

    Where the taxable income allocated to the charity aligns with its economic result (eg the charity receives distribution broadly aligning with the profit of Finance hold co or its net income (if trusts are used)), Part IVA is unlikely to apply.

    The Australian long-term investor

    Assessability of distributions received from Project hold trust

    Where the Australian long-term investor is presently entitled to a distribution from Project hold trust, the assessable income of the Australian long-term investor will a proportionate share of the net income of Project hold trust. The net income of Project hold trust is defined to be, broadly, its taxable income.

    These concepts are elaborated upon in Division 6 of the ITAA 1936.

    Tax deferred distributions

    In some income years, the trust distributions may be comprised of accounting income in excess of the net income of Project hold trust determined under Division 6 of the ITAA 1936. The extent to which the distribution is in excess of the net income is a ‘tax-deferred distributions’ (TDD).

    In these situations, refer to our compliance approach.

    Broadly, under our compliance approach, on the assumption that the Australian long-term investor holds its investment on capital account, the TDDs will be treated as non-assessable amounts under the CGT cost base and reduced cost base rules.

    The Australian short-term investor

    The Australian short-term investor purchases the units in Project hold trust with a view to selling those units for a profit within a few years after purchasing them (usually after the end of the D&C phase).

    Often one of the consortium members will also be the D&C contractor. It may be the case that their purpose in being a participant in the project is to make a short-term profit from the construction of the asset, and have no intention of maintaining their ownership of the Project trust during the O&M phase.

    In this circumstance, the units are held on revenue account, and any gain or loss from the sale of them may be treated as ordinary income under section 6–5 or deductible section 8–1. See Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income for an explanation as to when this may occur.

    Additionally, if the Australian short-term investor receives a TDD (as explained above), refer to our compliance approach.

    Broadly, under our compliance approach, the TDDs will not be assessed as ordinary income provided that the TDD, including CGT concessional amounts, are fully taken into account in working out revenue gains and losses on those units.

    Hold trust 1 and Hold trust 2

    The tax treatment of Hold trust 1 and Hold trust 2 will depend upon whether they are managed investment trusts (MITs).

    If the trusts are not managed investment trusts

    If Hold trust 1 and Hold trust 2 are not MITs, then Division 6 and CGT will apply similarly to the way those provisions applied to the Australian investors.

    However, the beneficiaries of Hold trust 1 and Hold trust 2 are non-residents. As a result, the trustee of Hold trust 1 and Hold trust 2 will be taxed in relation to the beneficiaries. The trustee is taxed to assist in the collection of Australian tax on relevant income.

    Specifically, under section 98 of the ITAA 1936, the trustee of the trusts will be liable to pay tax on the foreign resident investor’s share of the net income of those trusts. If the foreign resident investors are companies, the current rate of tax is 30%. If it is an individual or a trustee of another trust, the current tax rate is 47.5%.

    If the trusts are managed investment trusts

    Hold trust 1 and Hold trust 2 may be MITs as defined in section 12–400 of Schedule 1 to the Taxation Administration Act 1953. See our publication What is an MIT under the new rules for the requirements for a trust to be an MIT.

    If the trust is an MIT, then

    • a special MIT withholding rate will generally apply
    • the trustee assessment mentioned above will not occur.

    Generally, the MIT withholding rate will be 15% for beneficiaries that are residents of tax information exchange countries. Details of the tax rates that apply to particular types of beneficiaries and types of investments are set out in our publication Withholding tax arrangements for managed investment trust fund payments.

    However, one of the key issues regarding whether Hold trust 1 and 2 will be MITs relates to the requirement that the these trusts not control, or not be able to control a trading business. The business of the Project trust is a trading business. If these trusts control the affairs and operations of the Project trust, those trusts will not be able to be MITs.

    See our draft discussion of what constitutes control for the purposes of these provisionsExternal Link.

    Importantly, the concept of control extends beyond positive control to include certain forms of 'negative control'.

    The foreign resident investors

    If the trust the foreign resident investors hold the units in is not an MIT, the tax assessed to the trustee in relation to the foreign resident investors is generally not a final tax. If the trustee is assessed under subsection 98(3) in respect of an individual or company beneficiary, those beneficiaries are assessed under subsection 98A(1) and allowed a credit under subsection 98A(2) for tax paid by the trustee.

    If the trustee is assessed under subsection 98(4) in respect of a trustee beneficiary, the trustee beneficiary and any later trustee in the chain of trusts is not assessed again on that amount under section 98, 99 or 99A. However, an amount may be taxed to an ultimate individual or company beneficiary under subsection 97, 98A(3) or 100 and allowed a credit under section 98B.

    However, if the trust is an MIT, and MIT withholding tax has applied to the payment, then the distribution to the foreign resident investor will be non-assessable non-exempt income.

    Tax treatment upon exit of the investment

    Here we outline the tax outcomes if an investor chooses to exit their investment.

    The long-term Australian investor

    CGT event A1 will generally occur if the long-term Australian investor sells its units in the project hold trust.

    In working out the capital gain from CGT event A1, and reduction in cost base as outlined above in relation to TDDs would need to be taken into account.

    The short-term Australian investor

    Because the units are held on revenue account, any gain or loss from the sale of them may be treated as ordinary income under section 6–5 or deductible section 8–1.

    However, note that for the short-term Australian investor to avail themselves of our administrative approach in relation to TDDs as outlined above, those TDDs must be taken into account in working out revenue gains and losses on those interests.

    The long-term foreign investor

    Generally, CGT will not apply to the long-term foreign investor selling its units in the project hold trust, subsection 855–10(1). This will be true so long as, consistent with the example being used, the assets of the project hold trust do not constitute taxable Australian property as defined in section 855–15.

    The short-term foreign investor

    However, the exemption for the gain upon the sale of the units in the project hold trust will not apply if any income from their sale will be treated as ordinary income under section 6–5. In working out the amount of ordinary income, consistent with our administrative approach in relation to TDDs, the amount of any TDD should be taken into account.

    The fact that there is an amount of ordinary income does not automatically mean that the gain is taxable in Australia.

    Because the short-term foreign investor is a foreign resident, any income from the sale will only be taxable in Australia to the extent that the income is from an Australian source. In determining whether the income from the sale is from an Australian source, the question is not dependent solely on where the purchase and sale contracts are executed in respect of the sale of the units.

    While issued in the context of the sale of the shares by a private equity fund, TD 2011/24 outlines some of the factors where we will consider when determining the source of the income from the sale of the units.

    Where the short-term foreign investor is a resident of a country with which Australia has a tax treaty, the business profits article will likely determine which country has the taxing rights in respect of any profit. It is generally the case that the country of residence of the profit maker will be entitled to tax those profits, although this may depend upon whether the interests of the short-term foreign investor are being held at or through a permanent establishment located in Australia.

    If there is no Australian permanent establishment, the short-term foreign investors in treaty countries will not usually be subject to tax on their Australian sourced business profits (although this will depend upon the terms of the relevant business profits article).

    That said, if the gain on disposal is not taxed under section 6–5, any residual application of CGT, subject to the provisos outlined above, would need to be considered.

    See also:

    • Taxation Determination TD 2010/20 in relation to treaty shopping arrangements, where the income gains may properly be taxed in Australia.
      Last modified: 30 Oct 2015QC 47235