Tax Transparent Companies: Striving for Tax Neutrality? A Legal International Comparative Study of Tax Transparent Companies and their Potential Application for Australian Closely Held Businesses

Abstract

An underlying issue which inheres in any taxation framework relates to the manner in which it operates and the actual distribution of its imposts or appropriations. In this respect, a tax system needs to confront two fundamental (and interrelated) questions – first, precisely how the tax or impost should be imposed and, secondly, who should bear the legal obligation or onus of payment. These issues can be conceptualised not only from a purely legal or positivist perspective, in terms of identifying who will incur the obligation to pay tax, but also in terms of a more economic and instrumental standpoint as to which entity or individual should effectively be paying the tax. These alternatives may not result in the same conclusions, particularly for the taxation of business forms. To provide one example, if the business form has separate legal entity status from its members, should the business form, as a legal person, be subject to tax separately from its members? From a legal standpoint the response to this question is that such a business form should bear the impost. However, from an economical perspective it may be preferable that the business income and/or losses are directly allocated to its members. Indeed, tax transparency (aggregate approach) has been argued as an economically superior model, although it is not without its critics.1 Criticisms against tax transparency include the risk to tax revenue and the potential to distort investment decisions when allocated losses exceed a member’s financial exposure.2 Despite these criticisms, several foreign jurisdictions have implemented tax transparency in relation to business forms that are characterised by separate legal entity status and limited liability for members (referred to as tax transparent companies or transparent companies). Prominent examples include the United States’ S Corporations and Limited Liability Companies (LLC), the United Kingdom’s Limited Liability Partnerships (LLP) and New Zealand’s Loss Attribution Qualifying Companies (LAQC). The Australian government has been reluctant to fully embrace transparent companies, preferring the integrated approach of a full imputation system applying to corporate distributions. However, in response to pressure for reform, the Australian government has recently introduced two transparent companies, although they are not broadly available.3 These Australian transparent companies are incorporated limited partnerships used for venture capital investments (venture capital ILPs) and amendments to controlled foreign hybrid companies (CFC hybrids). The question that needs to be raised in relation to the introduction of the foreign transparent companies entails precisely what were the underlying motivations that prompted their implementation in the first place. In particular, were these entities introduced purely on the basis of promoting tax neutrality, or were other factors or motivations influential in their creation? If, indeed, other factors were at play then this implicates the obvious question regarding the existence of similar factors in Australia – thereby, perhaps, facilitating the creation of the same type of entities in this jurisdiction. A further interrelated question that needs to be confronted is whether these foreign jurisdictions have ensured that their tax revenue is not prejudiced or affected through the allocation of tax losses to members who do not have full liability exposure. If this is the case, then the consequent concern implicated here is whether Australia’s present loss restriction rules would be able (in such a circumstance) to adequately protect tax revenue in the pursuit of developing such a tax transparent company? A final concern stemming from the foregoing issues is that, given the purported benefits that accrue to closely held businesses via tax transparent companies, how does transparency influence problems faced by this sector in terms of complexity, financing and governance. It is these relevant questions to which attention will be focused on in this dissertation. In addressing these pertinent issues, tentative recommendations for policy and legislative reforms will be formulated in the concluding chapters.