As foreshadowed by the Treasurer in the lead up to this year’s Federal Budget, the Government has announced a package of measures designed to address ‘multinational tax avoidance’. These measures appear to be a reaction to recent media reporting and designed to send a message that the Government is determined to protect the Australian tax base and ensure the Australian Taxation Office (ATO) is equipped with strong anti-avoidance measures applicable to ‘large’ multinational companies (MNCs).
Internationally and locally there has been growing public interest in the tax rules applicable to cross-border trade and investment. This includes interest in the compliance and enforcement of the current rules as well as a unified movement of tax reform to ensure that global tax rules remain current with business evolution.
The Organisation for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project, designed to reform the global tax rules on a multi-lateral basis, was announced almost two years ago and is due to conclude this calendar year. However, in the meantime, a number of countries have taken unilateral action. The most recent and prominent example is a new ‘diverted profits tax’ announced by the United Kingdom in December 2014 and effective from 1 April 2015.
Here in Australia, there has been public reporting of the tax affairs of, in particular, resource and technology companies, following the inquiry by the Senate into ‘corporate tax avoidance’ which is due to report to Parliament in early June 2015. The opposition parties have released their own tax reform proposals in the area.
The proposals announced by the Government in the 2015-16 Federal Budget are summarised below.
The Government proposes to amend the general anti-avoidance provisions (Part IVA of the Income Tax Assessment Act 1936) to tackle particular arrangements designed to avoid a taxable presence in Australia. The Treasurer has indicated that, based on ATO compliance activities to date, approximately 30 MNCs are likely to be affected by this measure. However, the companies have not been named and the Treasurer has refused to put a figure on the revenue likely to be raised by this measure. Based on recent public reporting and comments from the Commissioner of Taxation at the Senate inquiry last month, it would be fair to observe that technology companies are a target of this proposed measure.
Draft legislation has been released for this measure (referred to below as the ‘PE avoidance rule’), which is intended to operate from 1 January 2016 following consultation in relation to its design (with submissions due by 9 June 2015). Broadly, the proposed amendments would allow the Commissioner to tax foreign entities as if the foreign entity had supplied goods or services to Australian customers from an Australian PE. As a result, business profits attributable to the activities in Australia would be taxable in Australia and certain costs attributable to the deemed PE would be subject to withholding tax (e.g. interest and royalties).
This proposed PE avoidance rule is complex, but in broad terms, is intended to apply where all of the following features exist:
In relation to requirement 6 above, the threshold is 'principal purpose' and may include more than one principal purpose. This is designed to align with the BEPS Action 6 (prevent treaty abuse) and contrasts with the ‘sole or dominant purpose’ test in Part IVA more generally. In addition, the inclusion of foreign taxes is intended to address arguments that Part IVA cannot apply to schemes which mainly achieve foreign tax savings.
In relation to the ‘low or no tax’ test, the concept of ‘low tax’ is critical. However, no definition has been provided in the legislation and the examples provided are not informative. In addition, where a low or no tax jurisdiction entity exists within a group, the proposed rules effectively puts the onus on the foreign entity to evidence that the low or no tax entity is not directly or indirectly related to the Australian supply or that the entity has substantial activity in relation to the Australian supply. The operation of these various tests is far from clear.
Where these conditions are satisfied, the foreign entity will, in effect, be taxed on the basis that it is deemed to be carrying on a business in Australia through a PE and, as a result:
In addition, due to the proposal to increase administrative penalties (see below), the starting point would be penalties of 100 per cent of any tax shortfall.
Although not addressed in the material released today, it is apparently considered that the proposed PE avoidance rule will not breach Australia’s tax treaties because, under Australian domestic law, the general anti-avoidance rules prevail over tax treaties. This aspect of the legislation warrants careful consideration because it may be argued that the proposed rule goes further than our treaty partners may be expecting by deeming the foreign entity to have a PE and deeming certain expenses to be borne by the deemed PE for withholding tax purposes.
No guidance is provided in relation to the calculation of the ‘tax benefit’ obtained, presumably equal to the arm’s length profit of the deemed PE. This is likely to be an area of controversy and dispute for taxpayers potentially affected by this rule.
Interestingly, whilst the proposed amendments will operate in relation to tax benefits obtained on or after 1 January 2016, the draft legislation is clear that schemes entered into before this time will be caught by the new rules. However, the legislation does not explain how the various tests are to apply to, for example, arrangements that may have been established years ago when tax and business considerations were very different.
The PE avoidance rule is a departure from the general principle that Australia will not tax the profits of foreign companies doing business with Australian customers, unless those companies have a PE in Australia. It could be observed that the OECD BEPS Action Plan, specifically Action 1 (address the tax challenges of the digital economy), Action 6 (prevent treaty abuse), Action 7 (prevent the artificial avoidance of PE status) and Action 15 (develop a multi-lateral instrument), is intended to develop recommended changes to deal with the situations targeted by the proposed PE avoidance rule. For example, Action 7 is exploring the broadening of the PE concept to include circumstances where a local agent ‘negotiates material elements of contracts’. In our view, it is disappointing that the Government is proposing unilateral action ahead of the finalisation of the OECD BEPS project.
For income years commencing on or after 1 July 2015, MNCs with annual global revenue of $1 billion or more will be subject to an increased level of administrative penalties where there is a ‘scheme shortfall amount’ arising from tax avoidance schemes and profit shifting (transfer pricing) schemes. Under the proposal, where the MNC does not have a ‘reasonably arguable’ position (RAP), the level of penalties will be double the amount that applies under the current law. It appears that this new penalty regime is not limited to arrangements that fall within the proposed PE avoidance rule.
Given that the existing ‘base penalty amount’ that applies where there is no RAP is 50 per cent of the ‘scheme shortfall amount’, the doubling of this ‘base penalty amount’, to 100 per cent of the ‘scheme shortfall amount’, will act as a strong incentive for management to put in place governance procedures designed to ensure that the tax positions taken are appropriate and sustainable as a matter of law.
With effect from 1 January 2016, Australia will implement the new transfer pricing documentation standards of the OECD for all MNCs with annual global revenue of $1 billion or more. Under this measure, the ATO will receive the following from these MNCs operating in Australia:
Under exchange of information treaties with other countries (treaty countries), the revenue authorities of those countries will be able to access this information, in the same way that the ATO will be able to access the information obtained by those treaty countries that have adopted the new transfer pricing documentation standards of the OECD.
In announcing the implementation of the OECD’s new transfer pricing documentation and reporting standards it is not clear whether there is any intention to alleviate the potential overlap in compliance that exists under the recently introduced Australian transfer pricing documentation requirements.
The Government has also indicated that additional funding of $87.6 million will be provided to the ATO to continue its International Structuring and Profit Shifting (ISAPS) reviews. PwC supports the ATO being properly resourced in general and in particular to address arrangements contrary to Australia's international tax rules.
In the 'Fairness in Tax and Benefits' publication released with this year’s Federal Budget, the Government has highlighted a number of actions it will be taking to implement other aspects of the OECD’s work on BEPS including:
The Government has also asked the Board of Taxation to lead the development of a code on the public disclosure of greater tax information by large corporates. However, the Government warns that progress will be monitored and the Government will consider further changes to the law if required.
PwC supports factual and meaningful tax transparency that informs the national tax debate on tax reform and the Australian perspective on reform of international tax rules where this does not impose onerous compliance obligations on business. Referral to the Board of Taxation for consultation on a transparency code makes sense for the community and business.