Blackstone Chairman Stephen Schwarzman has warned Australia of a foreign investment “chill” following that country’s efforts to collect taxes on a windfall deal from private equity giant TPG. But according to reports in the Australian media, the government has for some time been discretely polling private equity firms to ask how paying taxes would influence their feelings about doing deals there. They’ll be reporting their scientific findings to the Treasury and Prime Minister
Schwarzman knows something about taxes, having earned over USD 702 million in 2008, making him the highest-paid US executive (Oracle’s boss was a distant second, with 557 million). Blackstone and TPG have been serious rivals in bidding wars, but TPG’s adventures with the Australian Taxation Office show that competitors know how to close ranks in the face of a joint threat.
In June 2006, TPG, together with management and another, smaller, private equity fund, led a buyout of Australia’s Myer department store chain, for AUD 1.4 billion (USD 1.04 billion), with 500 million in equity and the remainder financed through loans. Beginning the next month, the new owners starting selling off property and leasing it back. Within a year, the private equity investors had recovered their initial stake with the cash from the property deals.
Inventory was reduced by more than half in a huge selloff at some one-third of value; depots were shut and distribution centralized; a former Australian Miss Universe, whose face adorned the 2009 share offer prospectus (urging investors to buy “A piece of my Myer”), was hired for a 4 million dollar, 4-year promotional stint. The company took on new debt, issuing 250 million in notes.
The fire sale, the property selloffs and a downsized distribution worked financial wonders, at least on paper. While sales remained stagnant, operating profits increased by 17%
As stock markets recovered in 2009, Meyer’s private equity owners timed an IPO perfectly, returning the company to the public stock market in November 2009 with an initial share offering of AUD 2.4 billion which valued the company at AUD 2.8 billion.
TPG made a 400% return on its investment.
Those who bought the shares weren’t so lucky.MYR.AX lost more than eight percent on it’s first day of trading, removing AUD 200 million from the company’s market capitalization. On January 31, 2009, the stock was trading at a little over 3 dollars a share, down from its initial offering at AUD 4.10.
Shortly after the IPO, the New York Times Dealbook noted: the “catch” behind the stock offering and hefty profit for the former private equity owners: Selling property, noted the article, locks retailers into paying rent, exacerbating the effect of any sales decline.
Two weeks after the IPO, the Australian tax authorities determined that TPG owed AUD 620 million in taxes and penalties on the profits from the IPO and went looking for the money. A freeze was ordered on the TPG account set up to handle the deal. The account held 48 dollars.
To justify its claim, the Australian tax authority has proposed that profits from the disposal of assets acquired through a leveraged buyout be treated for tax purposes as revenue rather than a capital gain, which is taxed at a lower rate. The argument is straightforward: private equity funds are in the business of buying businesses, which provides them with a stream of revenue. Their profits should accordingly be taxed on that basis – as revenue.
Second, the tax office claimed that TPG set up its investment through a tax-avoidance scheme, exercised through a network of overseas and offshore structures in the Netherlands, Luxembourg and the Cayman Islands. Australia’s private equity lobby has vociferously contended that this is a normal scheme used by overseas and even domestic “asset managers” to avoid “double taxation” by headquartering the investment vehicle in a country with which Australia has a tax treaty.
The schemes exist, however, not to prevent double taxation, but to ensure little or no taxation.
Under the terms of a tax treaty, a foreign company operating in Australia can pay its income tax in the parent country. On paper, the Myer assets were held by a company in the Netherlands (which has a tax treaty with Australia) whose parent company is registered in Luxembourg. The mother of them all is (or was) something called TPG Newbridge Myer, registered in the Cayman Islands.. Under Dutch law, a subsidiary based in the Netherlands pays no taxes on dividends to a parent company registered in the European Union – which explains the function of the Netherlands- and Luxembourg-based shell companies interposed between Australia and the Caymans. Double taxation in this case equals no taxation. This explains the dire warnings coming out of Davos, but not the polling exercise of the Australian government, whose tax collectors have in fact issued a sound judgement.
The whole affair shows yet again the extent to which financial engineering and tax dodging constitute the foundation of the buyout business. Taxing these enormous profits could shave billions off public deficits and help finance public services and stimulate recovery at a time of massive unemployment. Foreign investors in Australia have already been exempt from capital gains tax for more than three years due to changes brought in under the previous right-wing government. For a Labour government to yield to blackmail at a time when governments including the United States and Korea are considering measures to increase taxation on private equity profits would be decidedly unhelpful. Australia in fact has no need to introduce changes to existing tax regulations to start collecting the money; the government only has to enforce what’s already on the books.