We are proud to present an episode of TaxTalks, the leading podcast for Accountants, featuring the CEO of Asena Family Office – Peter Harper. In this episode, Peter discusses how you structure into US public and private markets depends on whether you invest for cash flow or capital growth.

Tune in these upcoming weeks to listen to the second and third installments of this series on markets, investments, expansions, and taxes.

Transcript:

Peter Harper: The best way when you’re thinking about these rules, whether it’s LLC, these corporate regimes, or limited partnerships, is that they really do provide a lot of flexibility to navigate flows within a structure so that you’re either getting full flow through treatment if you want that, or you’re optimizing the optimal way of applying foreign tax credits against other parts of the holding company structure.

Announcer: You were listening to Australia’s podcast for Accountants Tax Talks, the podcast to grow your firm.

Heide Robson: Welcome to Episode 355 of TaxTalks. This is Heide Robson and thank you to Class for sponsoring this episode. When you invest into public or private markets in the US, so public markets like Nasdaq or the New York Stock Exchange and private markets like venture capital and seed funding and so on. When you do that, how should you structure these investments, trade through an Australian entity or set up a vehicle in the US? This is what Peter Harper of Asena Advisors will discuss with you in this episode. The first question to Peter is what common pain points and questions clients seek his advice on?

Peter Harper: So we talk about these complex questions. I want to caution listeners that each case that may come before them will be unique, and it is vital that they consult with someone that has us expertise in order to handle delicate matters. These topics are not simplistic and need experience and proficiency to tackle, so please reach out to us to address any issues that your clients may bring up with the diligence they deserve.

Peter Harper: It really does kind of two things. You know, a lot of the advice we’re giving is around either US direct investment where it’s folks are either, you know, their share trading or they’re looking at US based private equity or and so it’s structuring into an investment or it’s structuring into some form of operating asset where they’ve got an Australian business, they’re looking to expand into the US, they want to understand how to bolt that together. And a lot of the times there might be one or two founders or executives that are going to move over to the US together with the expansion. So any one of those we could start on any format and kind of lead into that.

Heide Robson: If we now look at Bob is doing significant share trading or share investment in the US. Could you run through how you would structure this in Australia and then also how you would structure this in the US?

Peter Harper: The biggest thing really depends on whether it’s going to be private markets or public markets when it’s public markets trading. So really it’s a matter of someone looking to build out a US-based portfolio and US public companies, it really is just focusing on the atypical structure that you’d be thinking about private investments for in Australia. And the reason for that is, as a general rule, shares as an intangible, they’re only subject to tax in the country in which the owner is a resident. So whether it’s an Australian company or an Australian trust, the tax, whether it was an income tax issue or a capital gains tax issue, depending on the volatility of trading, the only issues you’d be worrying about from a trading perspective would be Australian issues when it comes to withholding tax there are a suite of companies that are, you know, that are dividend paying companies. The yields on dividend-paying stocks in the US versus Australia are very, very different. You know, high-yielding dividend-paying stock in the US might be 2 or 3% which, compare that with Australia, a pretty average return. So it’s far less common in US public markets for people to invest for cash flow, then they’re normally investing for capital growth. So in that scenario, Bob would just be worrying about the returns in Australia.

Heide Robson: So the question of whether the withholding tax is 15% or 5% or 0% usually doesn’t matter so much because the yield is pretty low in the US anyway. Hence Bob would be investing in the US for capital gains and not for cash flow. Hence the withholding tax most likely won’t worry him so much. And the capital gain on these share portfolios since Bob is based in Australia, would be capital gains tax-free in the US. So you would only have to deal with capital gains tax in Australia, correct?

Peter Harper: That’s correct. And so as a result of this, it is rarer for folks to structure into trading operations in the US via US entities, right. If someone was coming from another country where there was some type of civil unrest or concerns about governance or whatever else, then yes, they might like to think that it’s more optimal to structure into a US vehicle for share trading. But in the context of Australia, I think the optimal structure is going to be just trading through either an Australian company or an Australian trust.

Heide Robson: Yes. Or individual?

Peter Harper: Yeah. Individual, yeah.

Heide Robson: You wouldn’t go through a US vehicle because trading from Australia is as good as it gets. When you are trading from Australia through an Australian entity, you have nothing to do with the US tax system apart from the withholding tax on the pretty low yield anyway. Why would you change that by trading through a US vehicle which now puts you into the US tax net?

Peter Harper: Correct. Correct. I think a lot of folks, when they hear about international taxation for the first time and they don’t have a lot of knowledge, their initial reaction is tax havens as a way to somehow get a reduced rate of tax. In my world, where you’re primarily looking at optimization for general business transactions, everyone’s core objective is just ensuring there’s not double tax because it’s far easier to get double taxed on returns than a lot of people would think. So if you can set up a structure like this where Bob can invest in the US market, if that’s really his objective, like he’s not doing this for any tax reason, his sole objective is an investment focused and accessing US public markets and there is absolutely no value in operating through a US vehicle.

Heide Robson: So that’s the public market. And now does the answer change for private markets?

Peter Harper: It changes in the sense that most private market deals are going to be structured through US partnerships. So the US LLC or US LPs, limited partnerships, and there was a very substantial case Grecian Magnesite that was passed down in 2017, I believe.

Heide Robson: Let me quickly tell you a bit more about Grecian Magnesite. So Grecian Magnesite was a Greek corporation and a partner in a US partnership. And then Grecian Magnesite sold its interest in the partnership. And the Tax Court found in 2017 that the profit from that sale was not US-sourced income and hence not subject to US income tax. That was appealed and went to the D.C. Circuit Court of Appeals in 2019 and the D.C. Circuit Court of Appeals affirmed the tax court’s decision. No tax in the US. Back to Peter.

Peter Harper: Prior to this case. And this was not a widely publicized point of view. And the reason it wasn’t widely publicized, I’ll get to in a moment, but prior to this case, the way the US tax rules worked was if you had an active partnership that was generating active income, that activity was segregated from the activities of the individual. So there wasn’t this notion where, okay, if you have got a partnership that’s generating US sourced income, that that automatically flows through to the underlying partner. Why that’s a substantial issue was you had situations where – and this was massive kind of in the hedge fund world – where people would have these substantial US operating businesses that were generating US sourced income where they could actually trade the interests in these partnerships offshore without US taxation. Right. And so what Grecian did, it came down and confirmed that position. As soon as that happened, the Trump administration changed the law so that any activity of a US based partnership that’s generating US sourced income will actually flow through to the underlying owner. Right.

Peter Harper: So we take this example with Bob. Bob’s investing in US private markets, assuming the US private market, let’s say it’s a real estate deal, so it’s generating US sourced income that is going to create a US tax footprint for him. Right. So it’s still mean that he might structure it into that deal through an Australian trust or an Australian company. But the answer is more complex because you’ve got to flow the – you’re now bringing into the situation a return that is US source subject US tax. We’ve got to ensure that we’re getting access to the foreign tax credits as they’re flowing through to the FITOs, as they’re flowing through to the underlying owner. And so, you know, that kind of makes the structural choices for private deals a little bit different. And so then the other question that this kind of then raises, because this is a very big kind of issue that is highly technical issue, that is very difficult for foreign advisors to get accustomed to. Cause the US notion of their check the box regime is very, very different from anything that exists in Australia. Right. So that fundamentally you’re dealing with this notion that eligible entities can pick their own path is whether they’re taxed, is disregarded entities, partnerships, corporates. But the mysterious thing about a US LLC is that if it doesn’t have a US trade or business, then you can have income generated by it. It’s not subject to US tax, right? So I think the correlation between a US LLC and the notion of what we thought a trust in Australia may have been to a lot of the recent cases that have sort of come down over the last couple of years in Australia dealing with sort of the Australian taxation of foreign sourced income absolutely holds true in the US. LLCs are fully flow through structures and the only way you are going to have income that’s subject to us taxes. If you’ve got a US title business and you’ve got effectively connected income.

Heide Robson: When you spoke about the partnership, if Bob did this investment in a private market and hence did this through a partnership, which entities would be in this partnership?

Peter Harper: The thing with that, when you set up an LLC, it is from a legal fiction and a tax fiction they are different, right? But purely from a tax perspective with an LLC, if you have a single owner of an LLC, it’s classified as a disregarded entity. Right. And I think sometimes I find with Australians that are new to this concept, they kind of just say pass through entity versus corporate. But that’s not true, it’s a disregarded entity. That’s the correct terminology. And really what that means, if you’ve got one owner, it’s taxed as a sole proprietor. If you’ve got more than two owners in an LLC and it’s taxed on a flow-through basis, then it’s going to be taxed as a partnership.

Heide Robson: Good. And so this is what you meant when you spoke about a partnership. Did you mean a multi-member LLC?

Peter Harper: Yeah. So you can either be a multi-member LLC or it can be a limited partnership. What you’ll generally find in the regulated investment world, all of the big funds will be structured through limited partnerships. LLCs are really the domain of private operating businesses or smaller scale investment vehicles.

Heide Robson: Good. And so now when you have either a multi-member LLC or a limited partnership, who are usually the partners to this, I assume are they usually foreign entities?

Peter Harper: It can be anyone. Whenever these structures are set up as an aggregator of investors, you know, they don’t have any nexus to the US tax system. So by virtue of being effectively an in-holding investment vehicle where all they doing are aggregating investments and then investing into some other structure, whether they’ve got a US trade or business will be dependent on the down flow of income. What I mean by that is let’s say Bob is an Australian company and he’s investing in a US LLC or a US LLP that is effectively an aggregation vehicle for investors. That vehicle in and of itself is not necessarily going to be something that’s producing US source income, right? It’ll be wholly dependent on the nature of the investment income that’s generated from the subsequent investment. Right. So if. They then, when invested in some other entity or business that was generating US income, US sourced income that would flow down through the structure and give Bob’s company this obligation to file a tax return in the US because it’s effectively receiving US sourced income.

Heide Robson: You mentioned FITO before and how to make sure that the FITO flows into the hands of the ultimate owners. That is quite difficult. As soon as you have companies in the structure correct to have a FITO flowing all the way through to the ultimate owners, you need trust all the way. Correct.

Peter Harper: Correct. What would generally happen is if you lose the benefit of the FITOs, it’ll get trapped at the company level. So in that example, we just go where we say, okay, we’ve got Bob, we’ve got our company. That’s the Australian owner of that investment. The foreign income tax offsets would be credited inside the company and so then you’re going to have a situation where you’re going to have a franking credit imbalance likely. And so you’ll have whatever your net effective economic outcome is based on tax that’s been paid along the way from a US sourced income down the way. And then you may have a franking credit deficit. So when you’re thinking through the structure or the structural choices, we are very focused on two things. Whether you are structuring for capital growth or whether you are structuring for cash flow, right. And when you’re structuring for cash flow. But in the example that we’re giving, let’s say, you know, you’ve got an Australian-based investor and you’re investing into a US-based private market asset that’s cash flowing, may or may not be producing US-sourced income. You want to assure that you have the most efficient pathway to get that income down to the ultimate owners. And so one other alternative can be to have a situation where you have an Australian trust make a check the box election to be taxed as a US corporation. Right.

Peter Harper: So the way the check the box regulations work is they basically say that to the extent that an entity is relevant to the US tax system and they are eligible – so they’re an eligible entity is classified by the US tax rules – they have the ability to make an election under the US tax rules to be taxed as a corporation or as a disregarded entity or a partnership. And so if an Australian entity is generating US-sourced income, it’s relevant. And Australia is a country that can result in the existence of an eligible entity. So by having an Australian trust make the election, what happens is you’ve got a US corporation for US tax purposes, right, which can be better because it eliminates the compliance obligations on the underlying beneficiaries to file US tax returns. Because if you had a situation where you have a US beneficiary of an Australian trust receiving US sourced income, then the ultimate beneficiary, the ultimate recipient of that income has an obligation to follow US personal tax return, right? Which for a lot of folks is not something that they want to do. So you can file an election, we tax the corporation. And so from a US perspective, you’re paying tax at the corporate tax rate, you’re filing one return from an Australian perspective because this election is irrelevant and you’ve got a flow-through entity that’s a trust. The FITOs that are generated from paying this US taxation can flow through to the underlying beneficiaries.

Heide Robson: This corporate election is that an 8832 election?

Peter Harper: It is. Yep.

Heide Robson: It’s good that you mentioned that. I didn’t realize that foreign entities can make an 8832 election. I thought that was only for US domestic entities, so it’s good to know that it’s possible. So now coming to this scenario, you describe that an Australian trust makes an 8832 election and hence is treated as a US corporation in the US. That means the trust pays US income tax but does that then give rise to franking credits and hence you don’t lose the FITO? Is that what you’re saying?

Peter Harper: No, no. It doesn’t give rise to franking credits. But what it does do, it gives rise to FITOs because from an Australian perspective they just see the fact that there has been tax paid on behalf of the ultimate beneficiaries. Right. And so therefore the foreign income tax offsets. So the biggest issue normally is because the company is paying the tax, but in this instance you’ve got the trust paying the tax.

Heide Robson: And hence it flows through?

Peter Harper: Correct.

Heide Robson: That’s very clever because it’s a trust that is paying the US income tax. It flows through to the beneficiaries and hence the ultimate owners are receiving a FITO.

Peter Harper: Yeah.

Heide Robson: So Bob investing into the public market and then also Bob investing into the private market, assuming the private market is a passive income vehicle. But actually what you said about the private market would also apply to an active business. It’s basically both.

Peter Harper: Yeah. And I think one really critical thing on that is that when I first encountered the check the box regulations, it’s not too dissimilar from Australia where you’ve got trust law and then you have tax law kind of being overlaid where you’ve got these two different concepts, right? So the kind of interesting thing about the check the box regulations, because they were really thought out, is you get this scenario in the foreign world and this is relevant to the controlled foreign corporations regime and whether you’ve got an active business, but you can establish structures whereby you can pick and choose which entity within a corporate tax frame where you want to make an election. And again, I’m jumping over the place a bit, but and this is sort of relevant to going back the other way, but it shows how powerful the regime is. You can have a situation where you could have a foreign holding company in a jurisdiction that might not have a lot of treaties or where you might like it for a bunch of reasons because it’s got a low tax base, but where there’s not a lot of activity, these are really just financial hubs, not operational hubs. And if you check the box over an active foreign subsidiary that’s earning income in a foreign market, that activity flows through to the ultimate holding company, thereby turning the revenue of the holding company into an active business. Right. The best way when you’re thinking about these rules, whether it’s LLCs, corporate regimes, limited partnerships, is that they really do provide a lot of flexibility to navigate flows within a structure so that you’re either getting full flow through treatment if you want that, or you’re optimizing the optimal way of applying foreign tax credits against other parts of the holding company structure.

Heide Robson: Welcome back. I like the idea of having an Australian trust making an 8832 election in the US, which turns the trust into a corporate entity in the US for tax purposes. So making an 8832 election in the US and then FITO for any tax paid in the US flows through to the beneficiaries in Australia without any tax leakage. I hadn’t heard of this before and I think it’s a very elegant solution. Before the interview, I asked Peter how Asena Advisers came about and what they do. Here is Peter’s answer.

Peter Harper: So in 2010, I moved from Australia to the US to set up the office of what is now Asena Family Office. At the time I was working in a business that was more of a traditional accounting business that was structured around tax compliance, accounting, and consulting. Then about eight years ago, I was appointed by a wealthy individual to set up a single-family office, and at the time there was just a whole bunch of things within the existing infrastructure of a traditional firm. It didn’t work. We needed access to multifaceted skills across accounting deals and consulting that wouldn’t have existed in a traditional practice. So we set about either building from scratch or buying interest in firms that could facilitate that. So today we’re a full-stack multifamily office across accounting, tax, estate planning, wealth management, and transactional services – so corporate finance and mergers and acquisitions.

Heide Robson: Welcome back. In the next episode, episode 356 let’s talk with Peter Harper about expanding a business into the US. So today we spoke about passive investments into private and public markets. And next week let’s talk about business expansions into the US. Until then, thank you for listening, and thank you to Class for their support. Bye for now and see you in the next episode.