The ascendency in recent years of the private equity sector has brought with it some unwelcome public profile and resultant scrutiny evidenced by the fiscal and regulatory reviews currently being undertaken in a number of prominent countries.

This scrutiny has now extended to Australia with both the Treasury and the ATO taking an active interest in the sector and a Senate Inquiry being established to review the sector. The Senate Inquiry is yet to release the results of its review, although this is expected on 16 August 2007.

On the tax side, there is no doubt that the ATO is gearing up to commence thorough reviews of the private equity sector as part of its 2007/2008 compliance programme. We are aware of the ATO forming particular teams to up-skill and obtain a detailed knowledge of the sector presumably as a precursor to the conduct of risk reviews and possibly detailed audits.

More specifically, in a speech given on 18 July 2007 by Michael D'Ascenzo, Commissioner of Taxation, at the Australian Institute of Company Directors, the Commissioner specifically indicated that as part of the 2007/2008 compliance programme, the income tax issues that the ATO would be examining will include:

"the structures used for large infrastructure projects and private equity deals, such as the characterisation and arm's length nature of payments to the investors or transaction fees, particularly where payments are made to a tax haven; compliance with thin capitalisation rules; and GST compliance on financial supplies and acquisitions."

The Commissioner also went on to state that:

"we will also be examining the role of investment banks and other intermediaries in promoting and facilitating merger, acquisition and divestment deals, along with the appropriate treatment of fees generated".

It is also to be expected that as part of these reviews, the ATO will examine what has become the controversial issue concerning the characterisation of gains as being revenue or capital, particularly as the issue pertains to carry.

In the knowledge therefore of what is ahead, we would strongly recommend that private equity managers be particularly vigilant in the following areas:

  • fund establishment and in particular, the drafting of relevant offer documents and the legal arrangements around providing managers with their carried interest entitlements;
  • investment and divestment structures used particularly in circumstances involving reliance on double tax treaty networks;
  • the characterisation of investment gains made on private equity investments; and
  • financing structures employed to facilitate private equity investments.

In the current environment, it may also be prudent to conduct your own prudential risk review to identify whether there are any potential tax risks that face either your business as a private equity manager or that expose your investors. In this regard, we are particularly conversant with many of the potential tax issues facing managers, investors and the sector more generally and would be pleased to assist you in such a process.

This publication is intended to provide a general information only and should not be relied upon as giving legal advice. For legal advice on a specific issue, please contact one of the lawyers at Gilbert & Tobin