21 April 2021
On 21 April 2021, the Australian Taxation Office (ATO) provided 19 pages of draft guidance in Practical Compliance Guideline PCG 2021/D3 (PCG) which sets out the Commissioner of Taxation’s approach to assessing whether a taxpayer has undertaken reasonable enquiries in relation to the imported hybrid mismatch rules.
The PCG sets out the level of supporting information the Commissioner expects taxpayers to obtain prior to filing income tax returns and to sustain deductions for payments to offshore related parties. The PCG is an important consideration particularly for taxpayers preparing income tax returns for the second year of operation of the Australian hybrid mismatch rules (i.e. year ended 31 December 2020 or ending 30 June 2021).
The PCG provides welcome guidance for taxpayers grappling with these rules in a self-assessment environment but does set a high bar in terms of the information and documentation expected to be obtained by all taxpayers in relation to the global operations of a multinational company (MNC).
The Australian hybrid mismatch rules were released in draft form in late 2017, enacted in August 2018 and took effect for tax periods commencing on or after 1 January 2019. It continues to be our experience that many subsidiaries of foreign MNCs are finding it challenging to interpret and apply this complex and novel legislation which can impact any related-party cross border payments (and in some cases, third party payments) that are otherwise deductible for Australian income tax purposes.
A key element of difficulty is the imported hybrid mismatch rule which requires Australian taxpayers to make judgments about the operation of foreign tax laws as well as the presumption that the Australian taxpayer has perfect knowledge of the overseas group structure, relevant foreign tax law and the flow of payments through the global group structure. This “tracing” exercise arguably may involve payments that have no direct or commercial link to payments made by the Australian entity and can make it very difficult to apply in practice. In our experience, this tracing rule typically goes further than other countries that have adopted the hybrid mismatch rules designed by the Organisation of Economic Cooperation and Development (OECD) as part of the Base Erosion and Profit Shifting (BEPS) project.
Australia operates a self-assessment system which places the onus on taxpayers to ensure compliance with the taxation laws. However, in many cases the information required to fulfil this obligation in relation to imported hybrid mismatches may not be available in Australia.
The PCG is designed to explain the ATO assessment of compliance risk associated with the imported hybrid mismatch rules including the level of documentation that is expected. The PCG is very detailed but the key elements and takeaways are are follows:
In December 2020, the New Zealand Inland Revenue released an exposure draft setting out the steps taxpayers are expected to have undertaken before claiming deductions for payments to offshore related parties under the imported hybrid mismatch rules. In most scenarios, the Inland Revenue’s expectation is that the New Zealand taxpayer will obtain a written statement from the group’s head office tax function confirming the steps that have been taken to ensure that there are no imported hybrid mismatches that have been funded by the New Zealand payer. The approach adopted by the Commissioner in the PCG appears to require a much more detailed work to be undertaken prior to filing the Australian tax return.
Practical compliance guidelines are not prepared for the primary purpose of expressing a view on the way a tax law provision applies and are not public rulings. Therefore, the PCG does not provide guidance in relation to any of the challenging interpretative issues associated with the imported hybrid mismatch rules and taxpayers are expected to adopt positions on these issues. For example, an important and potentially contentious issue is what countries may be considered to have corresponding foreign hybrid mismatch rules including countries in the EU and the United States which have adopted certain rules dealing with hybrid mismatches. This may impact the existence of an offshore hybrid mismatch under the top-down approach as well as the tracing that may be required under the bottom-up approach. The PCG also hints at potential ATO views, for example, the PCG expresses a concern about a view being taken that not all payments between entities must be traced.
All taxpayers making cross-border related party payments will need to consider the PCG and what work may be required to meet the proposed ATO requirements prior to lodging their Australian tax return. Although these ATO requirements are not required by law, it will be important to consider the consequences of not meeting ATO expectations including the tax return disclosures that may be required (after the PCG is finalised) and the impact on penalties in the event a tax shortfall is later identified.
Partner, PwC Australia
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Global Tax Leader
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Partner, PwC Australia
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International Tax Leader, PwC Australia
Tel: +61 3 8603 6247