RCF IV – game changer for the taxation of private equity investment in Australia?

Articles Written by Prashanth Kainthaje (Partner), Reynah Tang AM (Partner)

Key takeaways

A recent decision of a single judge of the Federal Court of Australia in Resource Capital Fund IV LP v Commissioner of Taxation [2018] FCA 41 (RCF IV Decision) has excited debate about the application of Australia’s income tax law to limited partnerships, particularly private equity and venture capital funds.

While the RCF IV Decision is now on appeal to the Full Court, there are important points from the decision that private equity and venture capital funds, and their advisers, should already be taking into account when structuring investments into Australia.

Background and decision

The dispute concerned whether and, if so, how income tax applied to the gains made by two Cayman Islands limited partnerships, Resource Capital Fund IV, L.P. (RCF IV) and Resource Capital Fund V, L.P. (RCF V), on the disposal of shares they held in Talison Lithium Limited (Talison). Talison was an Australian company, which carried on lithium extraction and processing activities in Australia.

The Court held that the partners in each of the limited partnerships were taxable in Australia on their respective share of the limited partnerships’ gain on the sale, but that the great majority of the partners (being residents of the US) were entitled to treaty relief.

While the overall conclusion is (in our view) unsurprising, the decision has caused some concern because of the views formed by the judge as to how the Australian income tax regime applies to limited partnerships, which differs from an earlier decision of the Full Court of the Federal Court of Australia in relation to a related fund.1

Summary of the RCF IV Decision

In summary, the Court held that:

  1. Relevant taxpayer: While a limited partnership is treated like a company for income tax purposes, this does not mean that the partnership is a separate taxable entity. Rather, it is the partners that are the taxpayers.  While the assessments were raised in the name of the partnership or the general partner of the partnership, and objected to similarly, the assessments and procedural steps should be understood as assessment to, and steps taken by, the partners by reference to the partnership name.
  2. Nature and source of the gain: As the evidence showed that the shares held by RCF IV and RCF V in Talison were held for resale at a profit, the amounts received on sale were ordinary income (rather than capital gains). The source of the gains was Australia because the ultimate profit was part of the entire business strategy, which included substantial activity in Australia.
  3. Availability of treaty relief: The US tax resident partners of RCF IV and RCF V were entitled to relief under the business profits article of the tax treaty between Australia and the US, unless those business profits were from the disposal of shares in a land rich entity captured by Article 13 dealing with the direct and indirect alienation of real property in Australia.Further, the Australian Commissioner of Taxation (Commissioner) was bound by his ruling in Taxation Determination TD 2011/25 to apply the business profits article, again subject to the operation of Article 13.
  4. Whether Talison was land rich: However, even though the concept of real property for the purposes of the treaty extended to mining rights, Talison was not land rich because:
  • In terms of valuing the right to mine lithium, the “net back” approach (ie. the value of processed lithium less costs of and return on downstream processing, transportation and marketing) adopted by the taxpayers was preferable to the Commissioner’s “market” approach (ie. based on the sale price of the shares less the value of identified downstream assets), as the latter approach included some value from the downstream operations.
  • Real property did not include buildings and plant related to the processing of lithium after its extraction as the mining lease held by Talison was not the source of the right to undertake the processing activities.

As a consequence of the foregoing and the applicant’s valuation evidence demonstrating that the value of the real property assets did not exceed the value of the other assets of Talison, the assessments which had been issued to RCF IV and RCF V were overturned. Subject to the appeal, this means that only the non-US resident partners were liable for tax on their share of the gain, on the basis that the gain was ordinary income with an Australian source.

Implications of the RCF IV Decision

We think the judge’s decision on the relevant taxpayer issues is likely to be overturned on appeal. Prior to the RCF IV Decision, the commonly held view among advisers, the Commissioner and taxpayers was that limited partnerships were taxed as companies for Australian income tax purposes. This is because the income tax legislation includes a specific regime3 which effectively deems a limited partnership to be a company for income tax purposes. In reaching his conclusion, the judge focussed on a narrow range of provisions dealing with the administrative aspects of how tax imposed on a limited partnership is to be collected, having regard to the fact that a limited partnership does not have separate legal personality under Australian law. However, in focusing on those provisions, it appears the judge failed to pay sufficient regard to the broader framework of the tax legislation, including that a limited partnership is now specifically identified as an entity which is liable to income tax.4

There was nothing particularly surprising about the judge’s decision that the gain on sale of the Talison shares was ordinary income. This was consistent with the evidence given, and the raison d'être of the most private equity and venture capital funds to turn a profit on their investment over a short to medium term time frame. In relation to source, the judge suggested that the analysis requires consideration of a variety of factors. Importantly, in this case, factors pointing to an Australian source included the presence in Australia of employees of a management company associated with the general partners of the funds, who sat on the board of Talison and also participated in the decision making of the investment committee of the funds relating to the investment in Talison. Disappointingly, the judge did not refer to another line of authority,which suggests the question of source should focus on “where” rather than “why” the profits are made. Even adopting the judge’s broader approach, there are steps that private equity and venture capital firms can and should be taking to manage the source risk.

The most welcome aspect of the decision was the confirmation that, absent a dealing in a land rich company, treaty resident partners of a foreign limited partnership that invests in Australia should generally be able to claim treaty relief from Australian income tax on any gains under the applicable business profits article. This is consistent with the OECD’s guidance and the Commissioner’s approach, which the Court held the Commissioner was bound to adhere to. In the unlikely event that this aspect was overturned on appeal, there would inevitably be more pressure on the source question.


The authors have prepared a more fulsome analysis of the RCF IV Decision which is anticipated to be published in a forthcoming edition of Tax Notes International

Federal Commissioner of Taxation v Resource Capital Fund III LP [2014] FCAFC 37. See our previous analysis here.

Under Australia’s capital gains tax provisions, gains made by foreign residents on the disposal of direct and certain indirect interests in Australian real property are subject to income tax.

Income Tax Assessment Act 1936 (Cth of Aust.), Div 5A of Pt III.

Income Tax Assessment Act 1997 (Cth of Aust.), s 9-1.

Eg. Australian Machinery and Investment Co Ltd v Deputy Federal Commissioner of Taxation (1946) 180 CLR 9.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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