AUSTRALIA - Resource Capital Funds - Latest developments and impact on international structuring investments into Australia
There has been a series of tax decisions in Australia over the last several years involving Resource Capital Funds (RCF), a mining-focused private equity firm and its corporate limited partnership (CLP) entities. These have been closely followed, as they are relevant to the taxation of cross-border investments through entities that are fiscally transparent in the country of residence and investments by non-residents (such as hedge funds, private equity funds and venture capital funds) into Australia. They also address important tax issues including whether CLPs are liable to tax, determining the source of gains, valuation of assets, application of capital gains tax (CGT) to Australian non-residents and availability of treaty relief. This article briefly examines these decisions including the latest Full Federal Court decision in April 2019.
First dispute (2013)
The dispute originated over whether income tax applied to a gain made by a Cayman Islands CLP, RCF III, on the disposal of shares in St Barbara Mines Ltd (SBM), a listed Australian company conducting gold mining on mining tenements that it owned in Australia. RCF III consisted of one general partner (another Cayman Islands CLP) and approximately 61 limited partners, mostly resident in the United States (US). The case focused on whether the partnership could be taxed on the gain from the sale, whether a taxable capital gain had in fact been made and if the Double Taxation Agreement between the US and Australia (the DTA) precluded the issue of a tax assessment to RCF III.
Federal Court decision (2013)
In Resource Capital Fund III LP v Commissioner of Taxation  FCA 363 the Federal Court (FC) firstly held that the gain on the sale of the shares was not assessable in the hands of the CLP, but rather as being derived by the partners themselves. The FC also held that the CLP was fiscally transparent in Australia and the Australian Taxation Office (ATO) could not issue assessments to it. Article 13 (the alienation of property article) of the DTA allows Australia to tax gains on real property situated in Australia, including shares in a company the assets of which consist wholly or principally of such real property. The FC held that Article 13 authorised Australia to tax the US resident limited partners in RCF on their respective share of the gain from the sale of the shares. However, according to Australian CGT rules in Division 855 Income Tax Assessment Act (Division 855), a capital gain or loss upon disposal of an asset will be disregarded if that asset is not taxable Australian real property (TARP) which includes mining rights. The FC held that the shares were not TARP, as the market value of the underlying assets held by the CLP that were non-TARP assets exceeded the market value of the TARP assets (thus failing what is referred to as the ‘principal asset test’), therefore the gain was not taxable in Australia.
Full Federal Court decision (2014)
In Commissioner of Taxation v Resource Capital Fund III LP  FCAFC 37, the Full Federal Court (FFC) overturned the FC’s decision, holding that the CLP was not a US resident and was an independent taxable entity taxable in Australia and liable to tax on Australian sourced income. The FFC also disagreed with the interpretation of the principal asset test by the FC and concluded that the market value of the TARP assets did exceed the sum of the market value of SBM’s non-TARP assets, when valued as a bundle instead of individually, therefore the CGT exemption did not apply. The DTA could not be used to deny that liability to tax as RCF was neither a resident of the US nor Australia.
On 17 October 2014, the High Court refused the application by RCF III for special leave to appeal. The case left behind uncertainty on issues such as characterisation of mining company assets, the interaction of Australian domestic law and DTAs and whether CLPS are fiscally transparent and entitled to treaty relief. This opened the door for these matters to be reconsidered and clarified.
The second suite of tax cases followed a similar fact pattern but this time concerned income tax applied to gains made by two different Cayman Islands CLPs - RCF IV and RCF V - on the disposal of shares they held in Talison Lithium Limited (Talison), an Australian company, which carried on lithium extraction and processing activities with projects in Western Australia. RCF IV and RCF V sold shares in Talison and the ATO issued assessments to the CLPs directly, levying Australian income tax on the gains made on the disposal. The ATO contended that Article 13 authorised the taxing of the gains and section 3A of International Tax Agreements Act 1953 extended the operation of Article 13(2) to gains attributable to real property held through one or more interposed entities such at the subsidiary entities of Talison.
RCF IV and RCF V objected to those assessments. The partners firstly argued that they were the taxable entities rather than the partnerships of RCF IV and RCF V themselves. They also referred to Australian taxation determination TD 2011/25, according to which treaty country limited partners can be entitled to benefits under Article 7 (the business profits article) which provides that the business profits of an enterprise of a Contracting State shall be taxable only in that State, unless it carries on business in the other Contracting State through a permanent establishment (PE), thus governing Australia’s right to tax the profit realised on sale of shares.
Federal Court decision (2018)
In Resource Capital Fund IV LP v Commissioner of Taxation  FCA 41 the FC held that the partners in RCF IV and RCF V were the taxable entities rather than the partnerships themselves and were taxable in Australia on their respective share of the CLP’s gain on the sale. The FC also held that the sale of shares had an Australian source, despite the CLP and its partners being located overseas due to the significant involvement of individuals associated with the CLP in Australia throughout the term of the investment. The gain was held to be ordinary income and therefore prima facie assessable income for Australian income tax. However, the FC also held that the business profits article (Article 7) applied, entitling the partners to treaty relief thus exempting the profits from Australian income tax because the partners did not have a PE in Australia. Although the alienation of real property article (Article 13) could override Article 7, the FC held the domestic Australian taxing provision Division 855 applied to exempt the gain because the market value of the TARP assets was less than the market value of the non-TARP assets of RCF.
Full Federal Court decision (2019)
The recent FFC decision of Commissioner of Taxation v Resource Capital Fund IV LP  FCAFC 51 (2 April 2019) saw a comprehensive victory for the ATO. Firstly, the FFC held that RCF IV and RCF V were treated as companies for Australian income tax purposes and liable to pay income tax as the appropriate taxpayers and not the limited partners. The FFC further held that Division 855 did not exempt the gains from sale of the shares. This was because the FFC found that the FC failed to identify some of RCF’s mining leases as TARP, and that when these assets were taken into account the market value of the underlying TARP assets in RCF was greater than the market value of the non-TARP assets. This enabled the gain to satisfy the requirements of Article 13 which overrode treaty relief afforded by Article 7. Consideration of TD 2011/25, which only applies to Article 7, therefore had no application, but nonetheless the FFC did agree with the FC that the ATO was bound by TD 2011/25 in relation to RCF IV, RCF V and the partners. The FFC was equivocal as to whether TD 2011/25 was correct at law to allow the CLP itself to rely on treaty benefits (as opposed to the partners) so it will be interesting to see if the ATO withdraws or amends TD 2011/25 for any such future arrangements.
Some key takeaways
- A CLP is to be treated as a company for Australian income tax purposes, including as an entity which is liable to pay income tax and therefore is not treated as a flow through (fiscally transparent) entity for Australian tax purposes.
- The gain from the disposal of shares in an Australian company, in a private equity context, can be appropriately characterised as income.
- Even if a CLP is not a treaty-resident of the US in its own right, US resident partners are nonetheless capable of invoking a treaty, and obtaining treaty benefits where applicable. If the relevant article is the business profits article, then they may be able to rely on the relevant DTA to allocate taxing rights to their home country, however they must also consider whether the alienation of real property article could also apply and override the treaty benefits in Article 7.
The latest chapter in the series of RCF decisions provides some much needed clarity for fund investors with respect to who the taxpayer is in cases involving CLPs. However, there is still uncertainty with respect to what factors courts examine to determine source of a profit from the sale of an asset, the potential for partners of a CLP to be denied treaty protection under the business profits articles of a DTA, and on what basis Division 855 can be used to interpret Article 13, the alienation of property article, without adequately exploring the basis for doing so. In Australia the case also raises questions about how effective the Government’s new Asian Funds Passport (a multilaterally agreed framework to facilitate the cross border marketing of managed funds across participating economies in the Asia region) that took effect on 1 February 2019 will be, given it relies on CLPs. The taxpayer has applied for special leave to appeal to the High Court from the decision of the Full Federal Court in FCT v Resource Capital Fund IV LP  FCAFC 51. There may yet be another chapter in this saga.