Why did the Tax Office move against TPG when it sold Myer?

It's worth asking because the Treasurer has been warned the action threatens "the nation's ability to fund billions of dollars in much-needed infrastructure"

Mark Westfield provides the clearest explanation I've read.

And he thinks the warning his crap.

His Business Spectator piece is entitled Too Clever by Half

It's gated, but registration's free.

Some highlights:

Frankly, Australia does not need TPG. When the overall wash-up of the Myer investment is examined, TPG invested $500 million of its own money (plus borrowed funds of $900 million) and took out $2.4 billion. The Myer shares taken up by the hapless investors in the float at $4.10 in early November are now valued by the share market at $3.70. TPG and its co-investors recouped their investment from income from the Myer business and asset sales so the float was pure profit. Thanks TPG.

The dire predictions from the private equity sector relate to the Howard government’s initiative in 2006 to exempt from capital gains tax indirect investments such as shares by foreign investors.

What former Treasurer Peter Costello didn’t envisage when he granted this exemption was the later behaviour the private equity investors might engage in. Three years later, one has to wonder why, if TPG is exempt from capital gains on the sale of Myer, it routed the cash proceeds of the sale through entities in the Netherlands, Luxembourg and the Cayman Islands...

The test applied by the ATO was whether this routing of money through the world’s tax havens was important to the commercial basis of the transaction, or whether it was merely to avoid tax.

It is this all-too-smart behaviour by TPG which attracted the ATO’s attention and prompted the use of its catch-all anti-avoidance provision, Part 1VA. The ATO has also assessed TPG’s profit as “income” rather than an exempt capital gain under its understanding as to how private equity operates...

What Part 1VA did, controversially, was to reverse the onus of proof. The taxpayer had to prove it hadn’t used a contrived scheme to avoid tax. The Federal and High Courts have added to the burden of this onus over the past 20 years.

How can any government justify to its 10 million pay-as-you-earn workers the imposition of tax regardless of their financial position when a group like TPG can make a $1.4 billion capital gain and pay no tax? It can’t and it won’t.


Related Posts

. Thursday Column: What were they thinking? The tax heists that made us a nation of losers

. What the hell were we allowing the foreign equity fund owners of Myer et al to do?

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Ian Macfarlane's worried, Glenn Stevens is worried...

The former head of the Reserve Bank says “major financial instability” is likely to hit Australia within the next two decades and he believes we lack the tools to deal with it.

In the sixth and final of his Boyer Lectures to be broadcast on the ABC on Sunday Ian Macfarlane says he believes that Australia faces a threat “greater than the threat of inflation, deflation, the balance of payments and the other familiar economic variables that we have confronted in the past”...

The former Governor says he is concerned about the effect of performance-based pay on fund managers who are under increasing pressure to lift returns. “There is an incentive for them to take on more risk, particularly to hold assets that offer a high expected return in order to compensate holders for the possibility that, in rare circumstances, there will be a huge loss. It can have the effect of encouraging managers to chase short-term profits, even if long-term risks are being incurred, because if the risks eventuate, they will show up on someone else’s shift,” he said.

Mr Macfarlane’s comments amplify those made by his successor as Reserve Bank Governor Glenn Stevens who on Tuesday expressed concern about the growth of leveraged buyouts funded by private equity firms of the type that have bid for Qantas and Coles Myer.

Until this year leveraged buyouts in Australia in Australia averaged only $1.5 billion each year. This year up until Thursday the total was an unprecedented $13 billion. The Qantas deal, announced on Thursday, adds another $11 billion to that total.

Dr Stevens said that leveraged buyouts by private equity funds were essentially bets by that share prices would remain strong and that the cost of funding their debts would stay low.

The funds typically borrow heavily to buy and privatise large public companies, refloating them on the stock exchange five to ten years later at what they hope will be a profit.

Mr Macfarlane said the Australian public was more exposed to the fallout from any collapse in financial markets than ever before. Household debt was at an all time high. Many people had “taken on higher levels of debt than they desire, because they felt it was the only path to home ownership, given the strong rise in house prices over the past decade.” And more than half of adult Australians now owned shares directly, and many more through superannuation funds.

The former Governor said that the growth of superannuation and with it a shift to share market-based accumulation funds had increased the exposure to risk.

Whereas once employers had shouldered financial risks for their workers by offering defined-benefit payouts now most super payouts depended on the earnings performance of a particular fund. “In other words, it depends on what happens to share prices, bond yields, property prices and so on,” Mr Macfarlane said.

“I do not wish to criticise the current arrangements for retirement incomes in Australia because over time they will allow most people to retire on higher incomes than formerly. The only point I wish to make is that for a large part of the population, their standard of living in retirement will depend to a significant extent on how the value of financial assets perform, and hence they are more exposed to financial risk than under earlier arrangements.”

Mr Macfarlane said that the increased exposure to financial markets and the increased tolerance of risk in those markets was likely to make the economic effect of future booms and busts bigger.

He said he expected such a challenge within next two decades and he doubted that the public would accept the Reserve Bank pushing up interest rates to prevent it.

“If the central bank went ahead and raised interest rates, it would be accused of risking a recession to avoid something that it was worried about, but the community was not,” he said.

The Reserve Bank had “a very limited armoury with which to fight against a potentially dangerous asset price boom”, its chief weapon being jawboning in the form of speeches, parliamentary testimony and research papers, which was “of limited effectiveness”.

“How would [the Reserve Bank] cope if it faced an asset price boom of the magnitude of those that occurred in the United States in the 1920s or Japan in the 1980s? Not very well, I expect, but it would probably be held largely responsible for the distress that accompanied the bubble’s eventual bursting,” the Mr Macfarlane said.

The lecture will be broadcast at 5.00pm Sunday on Radio National. The series will be published as a book by Allen and Unwin entitled The Search for Stability.

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The Governor is worried...

About private equity funds. I outline his concerns this morning, as detailed below the fold

Australia's Reserve Bank says it is concerned about the growth in
leveraged buyouts financed by private equity funds.

In his second speech since becoming Reserve Bank Governor Glenn
Stevens said last night that leveraged buyouts of the type arranged
for Channel Nine and proposed for and Qantas were increasing
Australia's venerability to financial stress.

He said that the Bank and Australia's big private banks recently
conducted a macroeconomic stress test in which they simulated the
effect of a very large fall in house prices, a recession, a big rise
in unemployment and a sharp depreciation.

He said there were no widespread loan defaults and the banks
themselves remained "well and truly solvent".

However he said if leveraged buyouts mainly funded by private equity
funds continued to expand the results would become "more worrying".

Until this year leveraged buyouts in Australia were worth around $1.5
billion per year. In 2006 they jumped to around $13 billion.

Mr Stevens said that number still accounted for only a small
proportion of Australian mergers and acquisitions, but there was a
feeling that the growth could continue. The buyouts were essentially
a bet that Australian share prices would remain strong and the cost of
debt would stay low.

"We may at some stage face less forgiving circumstances than we have
enjoyed over the past decade," he said. "We need to be alert to the
shift in the wind in the area of corporate leverage that seems to be
occurring. I suspect we will be talking about that for some time to
come."

Dr Stevens told the Committee for the Economic Development of
Australia in Melbourne that he wanted to perform financial stress
tests more often.

"We have indicated to the chief executives of the participating banks
that we would look to do this type of stress test roughly once every
two years, and I look forward to their support for this," Dr Stevens
said.

In answers to questions at the CEDA dinner Dr Stevens said that he
that the housing construction cycle may have bottomed out.
Australia's very low rental vacancy rates lent support to this view.

He that his opinion about Australia's economic outlook had not changed since the Bank's last hike in interest rates in early November.

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Tuesday Column: private equity - it's my money!

Ever get the feeling that you have been here before?

The new breed of “private equity” funds are on the rampage. CVC Asia Pacific has bought half of the company that owns the Nine Network for $4.5 billion, Kohlberg Kravis Roberts has bought half the Seven Network for $4 billion, Newbridge Capital bought Myer for $1.4 billion, and now Texas Pacific, in partnership with the Macquarie Bank wants to spend $11 billion on Qantas.

Worldwide the value of new so-called private equity takeovers is said to double every 12 months.

And yet somehow it all seems familiar...

Back some two decades ago in 1987 when I was working as a reporter at the Sydney Stock Exchange an announcement come over the loudspeaker that seemed to make no financial sense.

An equity consortium headed by the then 26-year old Warwick Fairfax planned to spend what was then an obscene amount of money ($2.25 billion) taking the newspaper-publishing company that bore his name private.

Most of the consortium’s funds were borrowed and after the takeover Fairfax would disappear from the stock market.

The deal would only make financial sense if Fairfax was really worth far more than the stock market had believed it was. In other words, if the market had got it wrong.

It was driven by very easy access to finance (remember this was the newly-deregulated 1980’s), a tax regime that encouraged borrowing, an optimism about how the company could be freed up to make money if it was taken private, and the fees that would be earned by the geniuses that put together the deal.

As it happened it all ended very badly. Much of Fairfax was sold (The Canberra Times, the Seven Network) or closed down (The National Times, the Sydney afternoon Sun); Rothwells, the merchant bank that arranged the finance collapsed bringing down the Western Australian state government; and Warwick Fairfax lost his part of the family fortune.

Right now the new explosion in private equity buyouts feels to me like the debt-fuelled takeovers of the 1980’s did at the start.

After some initial astonishment they are being treated in the press as if they are works of genius. If the Nine Network, the Seven Network and Qantas are suddenly worth twice what they were, it must be because the share market has it wrong. It couldn’t possibly be because the financial engineers behind the deal don’t understand what they are taking on.

The faceless predatory private equity funds of this decade are being driven by similar forces to those that drove Australia’s colorful “entrepreneurs” in the 1980’s.

Our tax regime encourages takeovers fuelled by debt. Back then takeover merchants such as Robert Holmes a Court, John Elliot and Alan Bond could negatively gear – get the taxpayer to fund half their borrowings. Today the capital gains tax paid by foreigners who buy an Australian company and then sell it is extraordinarily low, and set to get lower. Legislation now before the Senate will eliminate the capital gains tax paid by foreigners on non-real estate Australian assets.

The Australian economy is strong and our sharemarket looks set to keep climbing – just as it did back in 1987 (ahead of the crash). It’ll need to keep climbing in order for the private equity funds to double the worth of the Nine network etc and get their money back.

And just as in the 1980’s money is incredibly easy for the funds to get. And not just from lenders. Although, not commonly realised, Australian superannuation funds are big investors in private equity funds.

Among the biggest is Australia’s biggest public sector superannuation manager, named ARIA, the Australian Reward Investment Alliance. If you haven’t heard of it that’s because its only recenly changed its name. It used to be called the CSS/PSS and it runs both of those funds. If you are a Commownealth Public Servant it is highly likely that ARIA is managing your money and pushing it in the direction of pivate equity funds.

ARIA’s Chief Executive Steve Gibbs says he won’t name the private equity funds. He uses about 15 to 20 of them, most of them Australian. All up they hold about 5 per cent of the ARIA’s funds and may soon hold up to 10 per cent per cent.

The way it works is that ARIA commits to give each of the private equity funds it deals with a certain amount of money. But it doesn’t actually hand over the money until the fund needs it to pay for a takeover.

After the takeover ARIA and the other investors in the private equity fund get no return whatsoever from the investment until the equity fund disposes of it at a profit. When that happens ARIA gets its money back and hopefully more.

As Steve Gibbs explains: “So we might say to a particular manager $50 million, and that’s a typical amount, we would say, okay we will commit up to $50 million, and over a five year period they will draw that down as they find good investments, and by the time they make their last investment, investing the last of the $50 million, we have probably got half of it back because of investments that have been realized.”

I suggested to Mr Gibbs that each deal that he put money into though a private equity fund was really a gamble that asset prices were going to continue to increase.

He told me that he never used the word gamble but that “what you are doing here is you are making an investment on the basis that once the investment is in the hands of one or more of these private equity managers they can help the company develop a strategy which will ultimately grow the company. It may be as simple as providing capital, it may be that the company has the strategy but doesn’t have the capital”.

You and I though our super funds are behind the new wave of private equity takeovers.
It’s a new wave fuelled by optimism and the belief that big companies are often the best ones. Lets hope that it turns out better than it did in the 1980’s.

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Qantas: bring on the spivs!

A takeover of Qantas led by money-hungry over-indebted American spivs could be the best thing that ever happened to the Australian traveling public. Not because the new owners would make Qantas more efficient and immediately pass on the savings to travelers. Quite the reverse.

The modus operandi of the new breed of American “private equity” funds such as the Qantas suitor Texas Pacific to load up their prey with debt and ramp up charges and the like to pay it off.

And anyone who has driven on a Macquarie Bank toll road or tried to catch a taxi or park a car at the Macquarie Bank-controlled Sydney Airport will know that Macquarie, Texas Pacific’s partner in the bid for Qantas, isn’t shy about jacking up prices either.

Not that they are likely to get the chance. The $11 billion takeover, still in the “preliminary discussion” stage according to Macquarie, is most unlikely to fly.

The Australian Competition and Consumer Commission gets to run its eye over takeover bids. Its Chairman, Graeme Samuel knows all about the Macquarie Bank. He was its Executive Director in the early 1980’s.

He knows too that the proposed takeover would see Macquarie controlling Australia’s busiest airport and owning 15 per cent of the airport’s biggest customer – the sort of arrangement that the ACCC was set up to stop, should it be likely to be anti-competitive.

The Treasurer gets a say as well. As the Minister responsible for the Foreign Investment Review Board he is able to block any foreign bid for the airline, even one that obeyed the letter of the law relating to Qantas and kept foreign ownership below 49 per cent.

He certainly won’t be easing that restriction in order to make it easy for the predator...
He said yesterday that Qantas “flies the Flying Kangaroo and the Flying Kangaroo says Australia - and as far as I'm concerned that means majority Australian ownership”.

The Foreign Investment Review Board guidelines are so broadly drawn that if the Treasurer so wanted he could block the bid for Qantas with as little as a phone call and a press release, as he did for the Shell bid for Woodside Petroleum in 2001.
With an election due next year and with the genuinely untested legal issues that would accompany a foreign bid for Australia’s national flag carrier there is every likelihood that he would.

The share market recognised this yesterday the Qantas buying stopped.
But what if the bid did succeed? What if Qantas became effectively American controlled?

It would lose the special place it has held in the hearts of Australia’s politicians. In the 13 years since Qantas at first became part-private under the Keating Government (and became one-third British owned) our politicians have continued to act as if what is in Qantas’s interest is in the nation’s interest.

They have blocked bids for competition on the Qantas’ rivers of gold – the air highways that stretch from Sydney to Los Angeles and from Tokyo to Sydney. All in the national interest, they have assured us.

The real national interest is in opening the skies to complete competition, so that we (and the foreign tourists who are considering coming to Australia) can enjoy world’s-best low prices when we travel.

An American takeover of Qantas, with the associated bad publicity about Qantas no longer being special and about jobs going offshore might just persuade our Government to flick the switch to full competition.

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