How is the investment structured?
Typically, the PPP structure will be established as a holding trust (Project Hold Trust) which will hold all the equity in an operating entity (Project Trust), as illustrated in Figure 6.
Typically, each consortium member will subscribe for equity in a Special Purpose Vehicle (Investor SPV) which will in turn subscribe for equity in Project Hold Trust, or alternatively the consortium member may invest directly in Project Hold Trust (illustrated in Figure 6). Some of the consortium members may initially invest into Project Hold 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 members will have longer investment horizons.
In some PPP structures, the equity in Finance Co will be held by a charitable trust, potentially via a holding company (depicted as 'Australian Charity' and 'Finance Hold Co' in Figure 6). Again, for clarification, a charitable trust is a trust that distributes its income entirely to one or more charities.
Figure 6: Typical consortium structure
Tax treatment of the investment
This section will examine the tax treatment for investors in a social infrastructure PPP.
- The Charity
- The Australian long-term investor
- The Australian short-term investor
- Investor 1 SPV and Investor 2 SPV
The Charity
If Finance Hold Co makes a profit, there may be a distribution to the Australian Charity. A discussion on the taxation arrangements applying to charities is outside the scope of this guidance and is dealt with in the not-for-profit section of our website.
Where the taxable income allocated to the Australian Charity aligns with its economic result (for example, the Australian Charity receives distributions of income broadly aligning with the profit of Finance Hold Co or its net income (if trusts are used)), Part IVA of ITAA 1936 is unlikely to apply.
The Australian long-term investor
Treatment of distributions received from Project Hold Trust
Where the Australian long-term investor (or its special purpose vehicle) is presently entitled to a distribution from Project Hold Trust, the assessable income of the Australian long-term investor (or its vehicle) will include its proportionate share of the net income of Project Hold Trust. The net income of Project Hold Trust is typically defined to be equal to its taxable income.
Division 6 of ITAA 1936 sets the framework around the taxation of trusts.
Tax deferred distributions
In some income years, the distributions by Project Hold Trust may be comprised of accounting income in excess of the net income of Project Hold Trust determined under Division 6 of ITAA 1936. The extent to which the distribution is in excess of the net income is a ‘tax-deferred distribution’ (TDD).
Under our compliance approach, on the assumption that the Australian long-term investor holds its investment in Project Hold Trust on capital account, the TDDs will generally be treated as non-assessable amounts under the capital gains tax (CGT) cost base and reduced cost base rules (see our compliance approach).
The Australian short-term investor
The Australian short-term investor purchases the units in Project Hold Trust (either directly or through its special purpose vehicle) 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 the D&C contractor's purpose in being a participant in the project is to make a short-term profit from the construction of the asset, with no intention of maintaining ownership in Project Hold 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 under section 8-1 of ITAA 1997. See Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income for an explanation as to when this may occur.
Under our compliance approach, TDDs will generally 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 (see our compliance approach).
Investor 1 SPV and Investor 2 SPV
The tax treatment of Investor 1 SPV and Investor 2 SPV will depend upon whether they are managed investment trusts (MITs) as defined in section 275-10 of ITAA 1997.
If the trusts are not managed investment trusts
If Investor 1 SPV and Investor 2 SPV are not MITs for a particular income year, then Division 6 of ITAA 1936 and CGT will apply similar to the way those provisions apply to the Australian investors.
However, the beneficiaries of Investor 1 SPV and Investor 2 SPV in Figure 6 are non-residents. As a result, the trustee of Investor 1 SPV and Investor 2 SPV 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 ITAA 1936, the trustee of the trusts will be liable to pay tax on the non-resident investor’s share of the net income of those trusts. For more information, see Tax on trust distributions to non-resident beneficiaries.
If the trusts are managed investment trusts
Investor 1 SPV and Investor 2 SPV may be MITs as defined in section 275-10 of ITAA 1997 for a particular income year.
For more information, see Management investment trusts – overview.
If the trust is a MIT for a given income year, then a special MIT withholding rate on distributions of fund payments may apply and if so, the trustee assessment under section 98 of ITAA 1936 as mentioned above will not occur.
However, one of the key issues regarding whether Investor 1 SPV and Investor 2 SPV will be MITs relates to the requirement that these trusts do not control (directly or indirectly), or are not able to control (directly or indirectly), a trading business. In this regard, we observe that:
- the business of Project Trust in a social infrastructure PPP is a trading business, and
- if Investor 1 SPV and Investor 2 SPV control the affairs and operations of Project Trust through control of Project Hold Trust, then Investor 1 SPV and Investor 2 SPV will not meet the requirements to be MITs.
Additionally, in determining whether Investor 1 SPV and Investor 2 SPV qualify as withholding MITs, particular care should be taken to ensure that:
- the trust is a managed investment scheme (within the meaning of section 9 of the Corporations Act 2001), and
- the trust carries out a significant proportion of its investment management activities in Australia throughout the income year.
We may apply compliance resources to ascertain whether purported MITs or withholding MITs satisfy these requirements.
Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 introduced several measures to limit access to concessions currently available to foreign investors for passive income.
Relevantly it provides that distributions from a trading trust (or a partnership or trust that would satisfy the definition of a trading trust) to a MIT (either directly or indirectly through a chain of flow-through entities) are treated as non-concessional MIT income and subject to MIT withholding at a rate of 30% (instead of 15% that would generally apply, depending on the country the beneficiary is resident in).
Project Trust is likely to be a trading trust because it carries on a trading business. Accordingly, income derived by Investor 1 SPV and Investor 2 SPV from Project Hold Trust will be subject to the 30% MIT withholding rate.
For details of the tax rates that apply to particular types of beneficiaries and types of investments, see Withholding tax arrangements for managed investment trust fund payments.
The foreign resident investors
If the trust that the foreign investors hold their Project Hold Trust units in (that is, Investor 1 SPV and Investor 2 SPV in Figure 6) is not a MIT for the given income year, the tax assessed to the trustee in relation to the foreign resident investors (as non-residents) is generally not a final tax. If the trustee is assessed under subsection 98(3) of ITAA 1936 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.
Where offshore beneficiaries are assessed under subsection 98A(1) and allowed a credit under subsection 98A(2) for tax paid by the trustee, the ATO would be concerned to ensure arrangements such as those outlined in Taxpayer Alert TA 2020/3 Arrangements involving interposed offshore entities to avoid interest withholding tax are not entered into.
If the trustee is assessed under subsection 98(4) of ITAA 1936 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 sections 98, 99 or 99A. However, an amount may be taxed to an ultimate individual or company beneficiary under sections 97, 98A(3) or 100, with the beneficiary allowed a credit under section 98B for the tax paid by the trustee.
However, if the trust is a MIT, and MIT withholding tax has applied to the distribution, then to that extent the distribution will be non-assessable non-exempt income for the foreign resident investor.
Tax treatment upon exit of the investment
The tax outcomes if an investor exits their investment are outlined below.
- The long-term Australian investor
- The short-term Australian investor
- The long-term foreign investor
- The short-term foreign investor
The long-term Australian investor
CGT event A1 will generally occur if the long-term Australian investor (or its special purpose vehicle) sells the units held in Project Hold Trust.
In working out the capital gain from CGT event A1 (including any reduction in cost base under CGT E4), TDDs would need to be taken into account, as outlined above.
The short-term Australian investor
Because the units in Project Hold Trust 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 under section 8-1 of ITAA 1997.
However, for the short-term Australian investor to avail themselves of our compliance 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 investors selling their units in Investor 2 SPV. 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 of ITAA 1997.
The short-term foreign investor
An exemption for the gain upon the sale of the units in Investor 1 SPV will not apply if any income from their sale is treated as ordinary income under section 6-5 of ITAA 1997. In working out the amount of ordinary income, consistent with our compliance 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.
Where the short-term foreign investor is a non-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.
Relevantly, the Full Federal Court of Australia considered the source of income derived from the sale of shares in Commissioner of Taxation v Resource Capital Fund IV LP [2019] FCAFC 51. The Court found that, though the agreements were negotiated outside of Australia, as a practical matter of fact the proceeds of the share sale had an Australian source. This finding was based on the:
- proximate origin of the rights to that income
- nature of the investment strategy including the active management of the investment
- location, extent and nature of the involvement of any employees and decision-makers in the investment strategy and active management of the investment
- location of any board members appointed to relevant entities by the investors
- location, nature and extent of income earning operations of the underlying business
- location, nature and extent of income earning property of the underlying business.
We consider an assessment of these factors will be relevant to determining the source of income derived from the sale of the units in Investor 1 SPV.
While issued in the context of the sale of the shares by a private equity fund, Taxation Determination TD 2011/24 Income tax: is an 'Australian source' in subsection 6-5(3) of the Income Tax Assessment Act 1997 dependent solely on where purchase and sale contracts are executed in respect of the sale of shares in an Australian corporate group acquired in a leveraged buyout by a private equity fund? outlines some of the other factors 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 (assuming the disposal is not 'land rich' and covered by the disposal of real property article). It is generally the case that only 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 held at or through a permanent establishment located in Australia.
If there is no Australian permanent establishment, the short-term foreign investor 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 of ITAA 1997, any residual application of CGT, subject to the provisos outlined above, would need to be considered.