Australia – new tax integrity measures announcedMay 29, 2015
As part of its 2015 Budget, the Australian government has announced a number of new tax integrity measures that target the tax avoidance and profit shifting aspects of certain international structures. The measures also endeavour to increase the efficacy of the local transfer pricing rules by requiring certain Australian taxpayers to provide three tiers of transfer pricing documentation as recommended by the OECD, increasing the compliance penalties associated with tax avoidance and profit shifting activities and announcing greater information sharing protocols designed to identify taxpayers that negotiate tax benefits arguably at the expense of the Australian tax revenue.
The new anti-avoidance rule
The Government has released draft legislation that seeks to expand on the current anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936. These proposed rules seek to address the much publicised issues associated with the digital economy and non-residents deriving income from the sale of goods or services in Australia that is otherwise not taxable in Australia.
The proposed legislation addresses situations where:
- a non-resident entity derives income from supplying goods or services to Australian customers with an entity in Australia supporting that supply; and
- the non-resident does not have a permanent establishment in Australia; and
- the non-resident is located in a no or low tax jurisdiction.
This means that the legislation is targeting multinationals that recognise the profits from sales in Australia in offshore low or no tax jurisdictions.
The proposed rules will only apply where each of the specific tests in the new rules are met and only if the company has a global turnover in excess of AUD 1 billion.
The proposed rule has some parallels with the United Kingdom’s proposed “diverted profits tax” (at least in terms of its intentions) and will apply from 1 January 2016.
The proposed rules only apply where the multinational has a presence in Australia that supports sales made to Australians by an offshore group entity. They will not therefore apply to sales (including internet sales) into Australia by companies that have no corporate presence in Australia. Those transactions may however be caught by proposed expansion to the Goods and Services Tax rules.
There are a number of aspects of the proposed rules, as drafted, that require further clarification. For example, the draft explanatory memorandum that accompanied the draft legislation talks of the new rules targeting tax havens. However, the draft legislation talks of “low and no tax” jurisdictions. This raises the question of what is a “low tax jurisdiction” in the context of these rules. The Australian Taxation Office (“ATO”) already has a list of “specified countries” that are part of the International Dealings Schedule, which constitutes the transfer pricing disclosure section in the annual tax return. The countries listed there are regarded as “tax havens”: however, they do not include, for example, Singapore which the ATO and the recent Senate Committee inquiry into tax avoidance clearly consider to be a low-tax jurisdiction and a conduit for tax avoidance schemes.
The proposed rules also provide a carve-out for where there is “substantial economic activity” conducted in the low or no tax jurisdiction in relation to the supply. In such cases, the rules don’t apply. However, again there is no clarity at this stage as to when exactly this carve out applies. For example, if we focus on Singapore again (as one of Australia’s top-five trading partners) and the investment incentives provided there under the Economic Development Board (“EDB”) incentive program, would a company that has established a regional sales entity under that program (with an appropriate level of economic activity, which is the prerequisite for the EDB incentive being granted) be exempted from these new rules? One would imagine that this carve-out would not be intended to exempt the likes of the technology companies that the ATO is so clearly targeting under the current laws at the moment. The “substantial economic activity” carve-out requires further clarification.
It is difficult to quantify the potential tax impact of the proposed rules. Although the level of Australia’s related party export trade is known, most if not all of the revenue targeted by the proposed rules is not recorded or recognised in Australia (they are not Australian-sourced under the current rules). Therefore, any quantification of the resulting tax is purely speculative. Furthermore, it is still yet to be seen how these rules will be applied by the ATO (including how certain aspects will be interpreted) and ultimately the Courts. One thing is for sure is that the affected multinationals will challenge the application of these rules (especially as for the rules to apply there must be evidence that the arrangement had a principal purpose of tax avoidance) and it will take some years before we see how effective the rules are in curbing what the Government sees as tax avoidance behaviour.
OECD three-tiered documentation
The Government also announced that the OECD documentation standards are to be implemented in Australia from 1 January 2016. This means that from that date the ATO will expect taxpayers with global revenues in excess of AUD 1 billion to have and provide (on request) all three levels of OECD documentation, being:
- The country-by-country (“CbC”) report;
- The Masterfile; and
- The local country documentation.
Australia has clearly decided to be an early-adopter of this standard: however, it is almost certain that many other countries will follow Australia and adopt this requirement. Multinationals need to start to work through the issues associated with this three-tiered documentation now in order to meet the upcoming compliance expectations of the various revenue authorities.
These documents must be available to the Australian entity (and therefore the ATO) irrespective of the turnover of the local entity. This may mean that these documents need to be available even where the Australian entity‘s turnover is very small in the context of the global group. In our opinion, a global turnover of AUD 1 billion is not a particularly high threshold and it is fair to say that a large number of Australian operations with turnovers of less than the ATO’s AUD 50 million threshold for simplified transfer pricing documentation will fall into this category. As such, it seems that this rule, which is intended to address the large and at risk multinationals, will cascade down to smaller and mid-sized multinationals irrespective of their Australian turnover and could place an additional and disproportionate compliance burden on those companies.
At this stage, it is not clear how this rule will interface with the recently announced simplified documentation rules for smaller low-risk taxpayers and whether the Masterfile and CbC report will still be required, if requested.
It is important to note that the Masterfile and CbC reporting documents are additional to the local annual Australian documentation that must be prepared in accordance with the local Australian rules and must address the five questions set out in Taxation Ruling TR 2014/8. These documentation requirements apply to all Australian taxpayers (entity or branch) with international related party dealings other than those that meet the simplified documentation concession. Therefore, taxpayers that may not need to produce the global Masterfile and CbC report for Australian purposes, still need to prepare local Australian documentation in order to evidence their compliance under Australia’s self-assessment rules.
Increased compliance penalties
The Government announced that the compliance penalties associated with avoidance and profit shifting will be doubled (to up to 100% of the tax shortfall), although it was noted that the penalties will not change where the taxpayer has a “reasonably arguable position” (i.e. has compliant transfer pricing documentation, which presumably includes having the OECD package available, at the time of filing the relevant tax return).
These increased penalties make the preparation of ATO compliant documentation even more important, remembering that the ATO expects that local documentation to address the specifics of the Australian taxpayer’s business. The local documentation needs to address (i) the arm’s length nature of the transactions / arrangements entered into by the taxpayer; (ii) the arm’s length amount of the pricing of those transactions / arrangements; and (iii) the commercial realism of the financial outcomes achieved from those transactions / arrangements. As is noted above, Taxation Ruling TR 2014/8 requires the documentation to address five questions and as such, Australian documentation will not constitute merely a localised version of a high level OECD-style Masterfile.
Compliance program funding
The Government announced it was providing the ATO with an additional AUD 88 million over the next three years to continue its International Structuring and Profit Shifting (“ISAPS”) program. This is the current big business transfer pricing project being run by the ATO involving 69 of Australia’s largest multinational companies, the details of which have been made public and discussed as part of an ongoing Senate Committee inquiry into tax avoidance and profit shifting.
This means that the ATO will have considerably more resources to continue to investigate the transfer pricing practices of multinational taxpayers in Australia. In this context, we note that the ATO has been streamlining its investigations functions and placing more personnel in the key risk areas, such as transfer pricing compliance. The ATO has also been increasing its data-matching capabilities to ensure the efficiency of its investigation activities in real risk areas.
Exchange of information
The Government also announced an exchange of information program between the ATO and other tax authorities designed to identify situations where multinationals have negotiated preferential tax deals in overseas countries that may contribute to tax avoidance in Australia.
Based on the matters made public at the Senate Committee inquiry, the ATO is heavily focused on the issues associated with the use of marketing hubs and other similar concepts in low and no tax jurisdictions by multinationals dealing with Australia. The ATO is aware of some of the tax incentives offered to multinationals by these jurisdictions and how those tax incentives are used by multinationals to obtain tax advantages. Whether the use of these structures constitutes either tax avoidance or non-arm’s length profit shifting is ultimately a matter for the Courts: however, it is clear that the ATO has strong views on these matters and is likely to prosecute these views more broadly with other taxpayers going forward.
Australia and the ATO are taking the lead in the Asia-Pacific region in terms of data sharing and cooperation between revenue authorities. This increased cooperation includes not only sharing intelligence but also developing joint audit strategies and issue identification processes, with the view to being able to audit multinationals on a multi-jurisdictional basis. The ATO has stated publicly that in order to deal with the global operations of multinationals effectively, revenue authorities need to think and act globally as well.
The Australian government has been under considerable political and media pressure to act in response to allegations of tax avoidance and profit shifting by multinationals, especially in the e-commerce space. In this regard, the Government has also expanded the Goods and Services Tax net to capture many of these e-commerce transactions. The proposals, especially in relation to the new anti-avoidance rules, are radical and untested ground: Australia endeavours to take leadership roles in tax and transfer pricing matters and this is an example of such an initiative. Whether this initiative is consistent with the agreed messages of international consensus and multilateral response to the Base Erosion and Profit Shifting (“BEPS”) issues espoused by Australia as the G20 Chair in 2014 is debatable. However, as the Australian economy struggles to adapt following the decline in iron ore and other commodity/resource prices, the tax aspects of international supply chains and transfer pricing have become political targets and potential vote winners and there is a real groundswell of political and public opinion that multinationals do not pay their fair share of tax in Australia.
It is interesting that in the politicisation of transfer pricing, the payment of tax (or the lack thereof) has seemingly become a question of morality. The Senate Committee inquiry in Australia (as well as in Britain and other places) has been focused not only on the legality of the transactions and structures entered into but seemingly also on the morality of those arrangements. Traditionally, corporates were governed by their fiduciary duties to their shareholders and these required the minimisation of costs (within the bounds of risk management) as part of the mantra of maximising profits and therefore shareholder value. It will be interesting to see whether tax morality and reputational issues impact shareholder expectations and the concept of “shareholder value” over the next few years.
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