Privateers blow a hole in the treasury chest

Sailing through the tax system by Elizabeth Knight

THERE is a nasty hole starting to appear in the Federal Treasury's tax receipts, thanks to the new phenomenon of private equity buy-outs. It's an amount that could easily hit $2 billion by next year, based on the deals that have been announced or completed to date.

And make no mistake - there will be more.

The reason for this is that assets that have been financially re-engineered by private equity owners generally pay little or no company tax.

Traditionally such companies had paid 30 per cent of their profits in tax - which formed an important part of Treasury's income.

But the game changes when private equity comes in. The new owners finance their acquisitions using debt, gearing the assets they acquire.

So instead of these assets earning healthy profits and paying tax to the Government they will be paying the profits away in interest to those financing the debt.

The potential for private equity to make a killing on its investment comes when the assets are sold some five to seven years later.

So in theory Treasury should make a bonanza profit in capital gains when the assets are sold. But here is the wrinkle.

Most of these private equity players are foreign corporations which, thanks to recent changes in the Australian tax rules, are now not subject to capital gains tax on these profits.

And even those that are Australian, I am told by Treasury officials, have found ways to minimise those capital gains payments.

[I]t is safe to assume that the tax paid on the capital gain won't offset the income tax that the Australian Tax Office will forgo when these companies pass to new owners. The Government's rationale in removing capital gains tax for foreigners was to stimulate offshore investment, laudable enough.

The only issue which needs to be taken into account before one writes off billions in corporate tax revenue is that those who sell these assets to private equity players may take a capital gains hit immediately.

In other words if I am a shareholder in Coles or Qantas or Rebel Sport and I sell my shares I could be liable for capital gains. But it's near impossible to calculate how much the ATO would collect from shareholders in those companies.

Some will be superannuation funds - large or self-managed - that pay a lower tax rate. Some could be sophisticated Australian investors that run their funds through offshore vehicles. Some will be foreigners, and some may have been investors that have made very little capital gain.

Put all these factors together and the upfront tax paid by those that sell to private equity probably won't make much of a dent on the overall tax revenue lost.

See: Privateers