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Australian Full Federal Court Holds Foreign Limited Partnership Liable to Tax; Reversing Earlier Decision — Orbitax Tax News & Alerts

On 2 April 2019, the Full Federal Court of Australia issued its judgment concerning the treatment of limited partnerships in the Cayman Islands with U.S. partners. In 2013, the partnerships realized gains on the disposal of shares in an Australian mining company, for which tax assessments were issued. The assessments were appealed, with the primary judge finding that the assessments were excessive because the partnerships were not entities liable to pay tax and the assessments issued to them should be understood as being assessments issued to the partners. Further, the judge found that the gains were entitled to the benefits of 1982 Australia-U.S. tax treaty, which does not grant taxing rights to Australia on gains from the alienation of shares unless the shares derived value wholly or principally (50%) from real property situated in Australia, which the judge accepted was not the case.

In its judgment, the Full Federal Court set aside the order of the primary judge.

In addressing whether corporate limited partnerships may be liable to tax, the Court found that "for the purposes of facilitating the treatment of a corporate limited partnership as a company for income tax purposes, and critically to enable such a partnership to pay franked dividends to its partners, the corporate limited partnership is a "person" upon whom is imposed a liability to pay income tax". With respect to who had been assessed, the Court disagreed with the primary judge that it was the partners that had been assessed.

In addressing whether the benefits of the Australia-U.S. tax treaty may be claimed in respect of its U.S. partners, the Court found that that partnerships could not claim the benefits because they could not be considered U.S. residents for the purpose of the treaty as there was no evidence that the income of either partnership was subject to U.S. tax. The Court also rejected the partnerships position that they could not be denied treaty benefits based on a 2011 ruling of the ATO (TD 2011/25), which includes that the business profits article (Article 7) of Australia's tax treaties apply to Australian sourced business profits of a foreign limited partnership where the partnership is treated as fiscally transparent in a country with which Australia has entered into a tax treaty and the partners in the partnership are residents of that tax treaty country. The application of the ruling was rejected because the ruling itself includes that the profits may not be dealt with under another article of the treaty; in this case Articles 6 (Income from Real Property) and Article 13 (Alienation of Property).

Lastly, the Court found that the primary judge had erred in accepting the so-called netback method of valuation used by the taxpayer, which resulted in the determination that the shares derived less than 50% of their value from Australian real property. Instead, the Court accepted a valuation by a government expert that resulted in the value from property exceeding 50% and, as such, the gain is taxable regardless of the application of the treaty.