UPDATE 1-Australia rules against private equity on tax

* Private equity firms must pay income tax on asset gains

* Industry wants government to change laws (Adds background and quote from private equity group)

CANBERRA Dec 1 (Reuters) - Australia ruled on Wednesday that gains from asset sales by private equity firms would be taxed as income, dealing a blow to an industry already struggling with nervous stock markets and a shortage of willing buyers.

The Australian Tax Office's (ATO) ruling also ensures that private-equity lobbyists will head to Canberra in the new year to call on the government to legislate to overturn the ruling, which they say will hurt Australia's investment reputation.

"The release today of the ATO's final determination clears the way for us to engage with the federal government to give foreign investors certainty on tax issues," the Australian Private Equity and Venture Capital Association said.

Wednesday's ruling stems from a dispute between the tax office and private equity firm TPG [TPG.UL] last year. TPG was hit with a $628 million tax bill on the $1.4 billion profit it made on the sale of department store chain Myer (MYR.AX).

The private-equity industry argues that gains on asset sales should be treated as capital gains, which are not taxable for foreign investors except in the case of real estate.

TPG declined to comment on Wednesday's ruling.

Wednesday's ruling specifically targets private equity firms that are domiciled in international tax havens.

The tax office, which is aggressive in tackling offshore tax avoidance, said it would crack down on offshore company structures it believed were being used to reduce their tax bills.

Foreign investors hold more than A$8 billion ($7.7 billion) in private-equity funds under management in Australia, the private equity association said.

($1=A$1.04)

(Reporting by James Grubel and Victoria Thieberger; editing by Ed Davies and Mark Bendeich)

(victoria.thieberger@reuters.com; +61 3 9286 1421; Reuters Messaging: victoria.thieberger.reuters.com@reuters.net))