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Australia, Cayman Islands: ATO win on treaty interpretation and valuation principles

04 April 2014   (0 Comments)
Posted by: Author: Chris Kinsella
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Author: Chris Kinsella (Maddocks)

This morning, the Full Federal Court found in favour of the Commissioner of Taxation over the capital gains tax on a $58 million gain made by a Cayman Islands fund in Australian gold miner, St Barbara Mines Ltd.

In two tranches, July 2007 and January 2008, a Cayman Islands investment fund (RCF III LP) sold its investment in ordinary shares in St Barbara Mines Ltd. RCF III LP had acquired the shares representing almost 12 percent of the capital of St Barbara in 2006.  St Barbara owned and operated gold mines in Australia and held extensive mining rights over Australian land.

The decision has important implications for foreign investors in Australian assets, particularly in the resources sector. It also has important implications for the interpretation of Australia's double tax treaties where Australia and its overseas treaty partner have different approaches to taxing a partnership. The decision develops the law regarding market valuations of assets requiring valuations to be approached on a going concern basis and not on the basis of some other hypothesis.

Maddocks acted for the Commissioner of Taxation. The decision is Commissioner of Taxation v Resource Capital Fund III LP [2014] FCAFC 37. The decision came down to two issues:

  • whether Australia was precluded from taxing RCF III LP by Australia's double tax treaty with the United States of America (treaty issue)
  • whether Australia was precluded from taxing RCF III LP by its own domestic tax legislation (Division 855) because the value of St Barbara's Australian land and Australian mining rights was less than the value of its other assets (valuation methodology issue).

First: the Treaty Issue

Some of the investors in RCF III LP were US residents who were only liable to Australian tax if the Australia:US double tax treaty provided that they were liable.

The US investors were partners in RCF III LP. Under US tax law, the partners were taxed individually on any income earned by the partnership. This meant, for example, that if an investing partner was a tax exempt charity in the US, it would not pay any tax in the US on its share of the gain derived by RCF III LP.

By comparison, under Australian tax law the partnership was liable to be taxed as if it were a company. Hence the individual tax attributes of a US investor were not relevant for Australian domestic taxing purposes. The Commissioner taxed RCF III LP directly on the gain it made.

RCF III LP argued that the treaty only authorised taxation of the partners, not the partnership.

The Commissioner of Taxation argued that the US investors were liable to Australian tax through RCF III LP as the treaty allocates to Australia, the right to tax gains derived by US residents from the sale of Australian land. The treaty defines Australian land to include shares in companies such as St Barbara, where the company's assets "consist wholly or principally of real property in Australia". The treaty further defines real property in Australia to include "rights to exploit or to explore for natural resources where the natural resources are situated or sought [in Australia]". The Commissioner led valuation evidence which supported his view that St Barbara's assets consisted principally of mining rights over Australian land.

The Full Court held that the treaty did not apply to preclude the Commissioner taxing RCF lll LP. It also rejected a RCF lll LP argument regarding TD 2011/25 as that ruling had nothing to say on Article 13.

Second: the Valuation issue

Broadly speaking, there were two competing contentions before the court:

  • RCF's argument: the mining rights should be valued on their own, as isolated single rights. Valued on this basis, the value of the mining rights and Australian land was less than the value of St Barbara's other assets (such as its cash, goodwill, mining information and mining plant/equipment).
  • Commissioner's argument: the mining rights should be valued on the basis that all of St Barbara's assets are used together as part of a going concern gold mining operation. The Commissioner argued that the market valuation should be approached by valuing the mining rights in their highest and best use. 

The Full Court held that St Barbara's assets should be valued on the basis of their highest and best use. The evidence was that the highest and best use was in an operating gold mine. Hence the Full Court held the mining rights should be valued on the basis that they were used together with the other assets used in an operating gold mine, in particular mining information (showing where the gold was situated and the best way to mine it) and the gold mining plant (which was installed and in use at the remote mining sites). On the facts of this case, that entailed valuing the:

  • mining rights as they were actually being used by St Barbara in a gold mining business operated as a going concern
  • mining information and plant equipment for less than recreation costs and with little or no time delay.

The Full Court noted that parties would need to consider how this would affect the final calculations before the final orders could be made.  

This article first appeared on lexology.com.


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