May 10, 2016
Following the United Kingdom’s initiative last year, the Australian Government is proposing to introduce a Diverted Profits Tax (“DPT”) as part of a series of initiatives designed to ensure that “large multinational businesses are paying the appropriate amount of tax on the profits they make in Australia”. The DPT initiative is complemented by the introduction of the Multinational Anti-Avoidance Law (“MAAL”) which is designed to “counter the erosion of the Australian tax base by multinational entities using artificial or contrived arrangements to avoid a taxable presence in Australia”. The Australian Government has issued a consultative paper (the “Discussion Draft”) that outlines the proposed Australian version of the DPT.
The Discussion Draft states that the objective of the DPT is to help ensure that entities operating in Australia cannot avoid Australian taxation by transferring profits, assets or risks offshore through related party transactions that lack economic substance, and to discourage multinationals from delaying the resolution of transfer pricing disputes. It acknowledges that the operation of the DPT rules reflects the fact that the rules can be difficult to apply and enforce in certain situations, particularly where a taxpayer does not cooperate with the ATO during an audit. It also states that the rules are intended to increase compliance by large multinational enterprises with their corporate tax obligations in Australia, including under the transfer pricing rules, and encourage greater openness with the ATO, address information asymmetries and allow for speedier resolution of disputes.
Main features of the DPT
The main features of the DPT are that it will:
Apply to income years commencing on or after 1 July 2017, whether or not the relevant transactions were entered into before that date;
Impose a penalty tax rate of 40 percent on profits transferred offshore through related party transactions with insufficient economic substance that reduce the tax paid on the profits generated in Australia by more than 20 percent;
Apply where it is reasonable for the ATO to conclude based on the information available at the time that the arrangement is designed to secure a tax reduction;
Provide the ATO with more options to reconstruct the alternative arrangement on which to assess the diverted profits where a related party transaction is assessed to be artificial or contrived;
Not operate on a self-assessment basis, unlike income tax. A liability would only arise if an assessment is issued by the ATO;
Require the upfront payment of any DPT liability, which can only be adjusted following a successful review of the assessment; and
Put the onus on taxpayers to provide relevant and timely information on offshore related party transactions to the ATO to prove why the DPT should not apply.
Transactions subject to the DPT
The DPT rules will apply where the Australian taxpayer of a significant global entity (refer below for discussion) enters into arrangement where:
The transaction has given rise to an effective tax mismatch; and
The transaction has insufficient economic substance.
The effective tax mismatch requirement
An effective tax mismatch exists where an Australian taxpayer (Company A) has a cross-border transaction, or series of cross-border transactions, with a related party (Company B), and as a result, the increased tax liability of Company B attributable to the transaction is less than 80 percent of the corresponding reduction in Company A’s tax liability. This is a strict rule and consideration will not be given to the circumstance for the reduction (for example different tax rates, the provision of tax relief and the exclusion of an amount from tax) and any other taxes associated with the transaction (such as goods and services tax or losses) will not be taken into account.
This means that the ATO will have a mechanism to potentially challenge any transactions that occur within a jurisdiction with a tax rate below 24% (based on the current Australian tax rate of 30%) where the ATO considers that the transaction lacks sufficient economic substance. These low-tax jurisdictions include Singapore, Hong Kong, Thailand and Vietnam in the Asian theatre.
The insufficient economic substance test
The second requirement for the DPT to apply is whether the transaction or series of transactions, or an entity’s involvement in that transaction, has insufficient economic substance. The determination of whether there is insufficient economic substance will be based on whether it is reasonable to conclude that transactions are designed to secure the reduction based on the information available to the ATO at the time of the test. Similar to the UK approach, where the non-tax financial benefits of the arrangement exceed the financial benefit of the tax reduction, the arrangement will be taken to have sufficient economic substance.
There is real concern that the ATO will use the DPT to issue assessments on transactions with lower-taxed jurisdictions whenever it feels that information is not or is perhaps unlikely to be forthcoming, to place the onus of proof squarely on the taxpayer in such cases.
Who does it apply to?
The DPT will apply to significant global entities that are Australian residents or are foreign residents with Australian permanent establishments. A significant global entity is an entity with annual global income of A$1 billion or more, or an entity that is a member of a group of entities, consolidated for accounting purposes, which has annual global income of A$1 billion or more. The Discussion Draft states that the DPT is not intended to target entities that do not pose a significant compliance risk, including significant global entities with small operations in Australia and therefore a de minimis threshold will exempt entities with Australian turnover of less than $25 million (this de minimis threshold is aligned to the small taxpayer category for simplified transfer pricing documentation purposes). However the de minimis test will not apply where income is artificially booked offshore rather than in Australia. Furthermore, where the significant global entity has multiple related Australian entities, the $25 million de minimis test will be calculated based on the total Australian turnover of the entities.
Quantera Global’s comments
It is concerning that the Government has again departed from the OECD's BEPS (Base Erosion Profit Shifting) action plan by introducing a new tax policy that is inconsistent with the BEPS recommendations. The essence of the Discussion Draft is a transfer pricing adjustment where the ATO considers an Australian taxpayer is not reporting a reasonable level of profit because of related party transactions with insufficient economic substance. The DPT seeks to empower the ATO to reconstruct arrangements in circumstances not permitted by existing anti-avoidance rules and arguably goes beyond the recommendations associated with the BEPS Action plans.
While, the Government has sought comments from interested parties in relation to the proposed DPT, the proposed DPT will likely invoke strong comments from the tax profession, legal fraternity and industries at large, as this represents a major shift in tax policy and process, effectively giving the ATO an unfettered default assessment power. This said, given the current political climate in Australia and globally, it is likely that the proposed DPT will proceed unabated. The Government has indicated that it will provide further guidance on the application of the DPT once the draft legislation is presented to the Parliament (although the timing of this is a little uncertain given the upcoming Federal Election on 2 July).
The Discussion Draft suggests that the DPT is only intended to address high-risk transactions and the ATO will have considerable discretion in its application. However, there is real concern that the ATO will simply issue assessments based on the available information (which may just consist of International Dealings Schedule and CbC information, especially where the taxpayer has not been able to provide further information) and then effectively place the onus on the taxpayer to disprove the assessments. This is potentially a massive shift in the ATO’s powers in relation to any transactions that occur with a jurisdiction with a tax rate below 24 percent. It is well known that the ATO has taken exception to a number of trading transactions entered into by Australian taxpayers with Singaporean companies and this legislation will doubtlessly give the ATO more ammunition to challenge those types of transactions. Similarly, it is likely that the ATO will use these rules to challenge intra-group funding arrangements that interpose conduit lenders in tax advantaged locations.
It will also be interesting to see how the Courts police exercise of the ATO’s discretion: it is reasonable to expect a number of administrative law challenges arising from the exercise of such a discretion, especially given that the diverted profits tax is payable in full upfront upon the issue of the DPT assessment and is based on a subjective assessment of (perhaps) limited facts.
We recommend that multinationals with any transactions that give rise to an effective tax mismatch from an Australian perspective undertake a prudential review to evaluate the economic substance of those transactions and to determine whether they can evidence that the transfer pricing arrangements associated with the transactions are consistent with the substance of the arrangements. Careful consideration needs to be given as to how to defend those transactions if they are challenged. It may be that some transactions will need to be restructured, especially any funding arrangements routed through tax advantaged locations.
The ATO is clearly being given an armory that is second-to-none in the tax fight with multinationals. The transfer pricing world is changing rapidly and while Australia may be at the forefront, other nations will need to enact similar measures to protect their tax bases. Ultimately this must lead to a significant increase in transfer pricing disputes and double taxation scenarios that may not be able to be resolved through mutual agreement procedures.
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