15 May, 2016
In the 2015-16 Federal Budget, the Australian Government announced the introduction of the multinational anti-avoidance law (MAAL), the doubling of penalties for large taxpayers engaging in profit shifting schemes (subsequently enacted by theTax Laws Amendment (Combating Multinational Tax Avoidance) Act 2015) and implemented the first tranche of the OECD’s recommendations as set out in the Base Erosion and Profit Shifting (BEPS) Action Plans.
The ramifications of last year's changes, and in particular the MAAL, are still being absorbed. One year on from this original announcement, taxpayers across the board are still engaged with the Australian Tax Office (ATO), spending a significant amount of time and effort discussing potential restructures to their Australian supply chains so as to be MAAL compliant.
Tonight, the Federal Treasurer Scott Morrison delivered the first Federal Budget of the Turnbull Coalition Government. Set in the context of "international headwinds and fragility", as well as an impending federal election, the Australian Government has announced more fundamental changes to our tax system, again under the guise of "ensuring multinationals are paying their fair share of tax". This significant package of measures, focused on taxpayers still exhausted from last year's changes, includes:
- an Australian diverted profits tax (DPT);
- applying GST to low value goods imported by consumers;
- anti-avoidance rules focused on eliminating hybrid mismatch arrangements;
- implementing the OECD’s recently updated Transfer Pricing Guidelines; and
- establishing a new Tax Avoidance Taskforce within the ATO to enhance its audit activity for large corporates and high wealth individuals.
In addition, there are a variety of technical changes to the consolidation regime and taxation of financial arrangements (TOFA) regime and fundamental reform to our superannuation system.
But it's not all bad news. The corporate tax rate is proposed to reduce to 25% – albeit progressively over the next 10 years.
The DPT
According to the Consultation Papers, the Australian DPT is " designed to ensure entities operating in Australia cannot avoid Australian tax 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". This is described as the Australian equivalent to the second limb of the UK DPT.
The DPT will apply to income years commencing on or after 1 July 2017 whether or not a relevant transaction was entered into before that date.
Significant global entities
Consistent with the MAAL, it will only apply to significant global entities with annual global income of A$1 billion or more (on a consolidated accounting basis).
As an improvement on the MAAL, a de-minimis threshold will exempt entities with Australian turnover of less than A$25 million (unless revenue is artificially booked offshore rather than in Australia). This aligns with the exemption for small taxpayers applying simplified transfer pricing record-keeping requirements (and hopefully will be extended to the MAAL soon).
When will it apply?
An arrangement with a related party may be subject to the DPT if:
- the transaction has given rise to an effective tax mismatch; and
- the transaction has insufficient economic substance.
If the related party arrangement gives rise to an effective tax mismatch, and has insufficient economic substance, the ATO may issue a DPT assessment. The assessment will be calculated by reference to the total of the Diverted Profits Amountmultiplied by the DPT rate.
What is an effective tax mismatch?
An effective tax mismatch will exist where an Australian taxpayer has a cross-border transaction with a related offshore party and, as a result, the increased income tax liability offshore attributable to the transaction is less than 80% of the corresponding reduction in Australia.
The following example (Example 1) is provided.
Company A has a A$100 reduction to its Australian tax liability as a result of a deductible payment, but due to the lower tax rate in Company B’s jurisdiction, Company B only has a A$60 increase in its tax liability from the corresponding receipt.
As the tax liability for Company B is less than A$80, an effective tax mismatch will arise. Available losses to the offshore related party will not be included in the effective tax mismatch calculation. This could arise where, as an example, a foreign resident provides marketing and administrative services to an Australian company for a fee. As Australia's tax rate is 30%, this covers all payments made to countries with a corporate tax rate of less than 24%.
Insufficient substance test
Determination of whether there is insufficient economic substance will be based upon whether it is reasonable to conclude based on the information available at the time to the ATO that the transaction(s) was designed to secure the tax reduction. This is a vague test in an Australian context. Further guidance is provided such that"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".
As an example, fees in excess of an arm’s length amount would be characterised as falling with this test.
Diverted Profits Amounts
For the purposes of determining the DPT assessment, where the deduction claimed is considered to exceed an arm’s length amount (‘inflated expenditure’ cases), the provisional Diverted Profits Amount will be 30% of the transaction expense.
However, diverted profits are not limited to excessive expenses. For any situations where profits have been diverted offshore, the provisional Diverted Profits Amountwill be based on the best estimate of the diverted taxable profit that can reasonably be made by the ATO at the time. (Examples of how this reconstruction power could apply are discussed in more detail in the two examples below).
(For completeness we note that, consistent with our current transfer pricing rules, where the debt levels of a significant global entity fall within the thin capitalisation safe harbour, only the pricing of the debt (and not the amount of the debt) will be taken into account in determining any DPT liability).)
DPT rate
The DPT rate will be 40% of the Diverted Profit Amount. Interest will be charged from the date tax would have been otherwise payable if the scheme had not been entered into. The DPT will not be deductible or creditable in Australia.
In calculating the DPT, an offset will be allowed for any Australian taxes paid on the diverted profits (e.g. Australian withholding taxes and Australian tax paid under the Controlled Foreign Company regime). However, there are no credits for foreign tax.
Process and review
The payment of tax has been accelerated compared with an ordinary review process for a risk review or audit.
Initially, a provisional DPT assessment may be issued by the ATO on review of a tax return (it is not a self assessment regime). That assessment will be issued as soon as practicable after the end of an income year and no later than seven years after the taxpayer has lodged its income tax return for the relevant year.
The taxpayer will then have only 60 days to make representations to correct factual matters set out in the provisional DPT assessment (but not on transfer pricing matters). Following this, the ATO will issue a final DPT assessment within 30 days and the taxpayer will have 21 days to pay the assessment and has no right of appeal against the final DPT assessment at this stage. That is, the tax payment is accelerated prior to the complete review.
The ATO will have 12 months to review the final DPT assessment, during which time the taxpayer may provide information to the ATO to support an amendment to the DPT assessment, which may include an adjustment on transfer pricing grounds. During this period, if the ATO considers the amount of DPT charged to be insufficient, the ATO may issue a supplementary DPT assessment up to 30 days prior to the end of the review period to impose an additional charge of DPT.
At the completion of this 12 month review, the taxpayer has 30 days to lodge an appeal through the courts.
Other examples
Importantly, the DPT is not limited to excessive deductions. Two other examples in the Consultation Papers show the potential breadth of the DPT to reconstruct transactions.
Example 2
Australia Co, Parent Co and Foreign Co are related parties.
Parent Co (a foreign resident) injects A$300 million equity funding into Foreign Co (also a foreign resident). Foreign Co uses the funds to purchase an asset, which it then leases to Australia Co. Australia Co pays A$30 million lease payments per annum to Foreign Co for use of the asset. Foreign Co has no other activities….
The ATO considers that the arrangement is artificial and contrived and that the relevant alternative scenario would have been that Parent Co would have provided equity funds to Australia Co to purchase the asset for its own use.
The ATO considers issuing a DPT assessment….
The Diverted Profits Amount is calculated by reference to the difference between the actual lease payment less a deemed hypothetical alternative depreciation expense. The DPT assessment is 40% of the Diverted Profits Amount plus interest.
Example 3
Australia Co, Foreign Co A and Foreign Co B are related parties.
Australia Co contractually transfers an intellectual property (IP) asset it has developed to Foreign Co A for a nominal amount. Australia Co continues to develop and maintain the IP. Foreign Co A only pays a small amount for this service and does not contribute in any other meaningful way to the further development or maintenance.
Foreign Co A charges Foreign Co B A$50 million royalties per annum for the right to use the IP……
The ATO considers that there is insufficient economic substance to the transfer and the relevant alternative scenario would have been for Australia Co to remain the owner of the asset.
The ATO considers issuing a DPT assessment….
The Diverted Profits Amount is the understated income of A$50 million. The DPT assessment is 40% of the Diverted Profits Amount plus interest.
This reconstruction power, and the DPT more generally, is a significant change in law that will need to be worked through by all significant global entities (unfortunately, potentially, replicating the last 12 months of compliance activity).
GST on imports of low value goods
The GST will be extended to low value goods imported by consumers from 1 July 2017. The intent of this measure is that low value goods imported by consumers will face the same tax regime as goods that are sourced domestically.
Overseas suppliers that have an Australian turnover of A$75,000 or more will be required to register for, collect and remit GST for low value goods supplied to consumers in Australia, using a vendor registration model.
Previously announced changes to tax imports of digital goods effective 1 July 2017 are set out on the Tax and Superannuation Laws Amendment (2016 Measures No. 1) Bill 2016, which is currently before Parliament.
Tax Avoidance Taskforce
The Australian Government will establish a new Tax Avoidance Taskforce to enable the ATO to undertake enhanced compliance activities targeting multinationals, large public and private groups and high wealth individuals.
This measure provides the ATO with a 55% increase in funding for compliance programs targeting multinationals and high wealth individuals. It specifically provides that it includes:
"a 43 % increase in resources devoted to tackling multinationals (including ramping up to an additional 390 average staffing level per year)".
This measure is estimated to have a gain to revenue of A$3.7 billion over the forward estimates period. No doubt two of the targeted areas of compliance will centre on the MAAL and DPT.
Enhanced transfer pricing rules
The Budget will amend the transfer pricing rules to ensure that the latest OECD Transfer Pricing Guidelines will apply in Australia. The OECD has substantially revised its transfer pricing guidance, particularly in relation to the recognition and pricing of intellectual property and other intangible assets. This new guidance enhances the ATO's ability to challenge transfer pricing arrangements which ascribe substantial value to intangible assets held outside of Australia. Even where such arrangements fall outside of the MAAL and proposed DPT, taxpayers need to closely review and monitor the transfer pricing position of their Australian operations to ensure that the principles of the new guidance are fully reflected in their intercompany relationships.
Increased penalties
On a similar theme, penalties for non disclosure will be increased.
Historically, companies have been subject to surprisingly low penalties for failure to comply with tax disclosure obligations. Penalties relating to the lodgement of tax documents to the ATO will be increased by a factor of 100 for companies with global revenue of A$1 billion from 1 July 2017. This will raise the maximum penalty from A$4,500 to A$450,000.
Penalties relating to making statements to the ATO will be doubled, to increase the penalties imposed on multinational companies that are being reckless or careless in their tax affairs.
Protecting whistleblowers
The Australian Government will introduce new arrangements to better protect individuals who disclose information to the ATO on tax avoidance behaviour and other tax issues. This measure will take effect from 1 July 2018 and is estimated to have an unquantifiable gain to revenue over the forward estimates period.
Under the new arrangements, individuals, including employees, former employees and advisers, disclosing information to the ATO will be better protected under the law, in relation to identity protection, and protection from loss of employment and legal consequences.
It is notable that the Australian Government has resisted taking the step of providing a financial incentive for employees to disclose confidential business information to government revenue authorities.
OECD hybrid mismatch rules
While the Australian Government has confirmed it will implement the OECD's recommendations to eliminate hybrid mismatch arrangements, it is low on detail. The Australian Government has asked the Board of Taxation to undertake further work on how best to implement the recommendations set out in the OECD's Base Erosion and Profit Shifting Action 2 Final Report of 5 October 2015.
Aside from asking the Board of Taxation to undertake further work on how to best implement the OECD’s recommendations, the Consultation Papers give little detail on the proposed new rules. The new rules are to apply from the later of 1 January 2018 or six months following Royal Assent of the enabling legislation.
Advisor disclosure
The Australian Government has also announced its intention to consult on a new set of rules requiring tax advisors to report aggressive tax structuring to the ATO.
These rules are likely to be strongly contested by the industry, particularly insofar as they clash with Australia’s well-established laws regarding legal professional privilege.
Changes to the consolidation rules
A variety of technical changes to the consolidation rules have been announced, including:
- extending the application of 2014-15 Budget's consolidation integrity measures for securitised assets to non-financial institutions with securitisation arrangements, which is intended to ensure consistent application to liabilities arising from securitisation arrangements within both financial and non-financial institutions for arrangements that commence on or after 3 May 2016; and
- removing adjustments relating to deferred tax liabilities from the consolidation entry and exit tax cost setting rules, to address the commercial / tax mismatch under these rules.
Interestingly, the proposed change to amend the consolidation regime's double counting of deductible liabilities when a consolidated group acquires a joining entity has been deferred from the original start date of 14 May 2013 to 1 July 2016.
TOFA rules
The Australian Government will reform the TOFA rules to reduce the scope, decrease compliance costs and increase certainty through the redesign of the TOFA framework. This will be through the following four key reforms:
- simplifying the accruals and realisation rules to reduce the number of taxpayers caught by the TOFA rules and reducing the number of arrangements where the spreading of gains and losses is required;
- aligning the TOFA rules more closely to accounting;
- simplifying the rules for the taxation of gains and losses on foreign currency; and
- amending the tax hedging rules so they are easier to access, cover a wider range of risk management arrangements and remove the direct link to financial accounting.
The new simplified rules will apply to income years on or after 1 January 2018. We are yet to see the details on the new rules.
Tax transparency code
Alongside the Budget announcements, the Board of Taxation today released its final report on a potential tax transparency code, which was commissioned by the Australian Government in the 2015 Budget. The Board proposes that a voluntary code be released that broadly encourages significant businesses to publish a range of additional tax-related information (including effective tax rates and summaries of cross-border dealings with related parties).
Company tax rate to be cut from to 25% by 2026
The Budget promises a staged reduction in the corporate tax rate from the current 30% (28.5% for small businesses) to 25% over the next 10 years – summarised in the table below. Franking credits are to be distributed at the rate of tax paid by the company.
| Financial Year | Annual Aggregated Turnover Less than | Company Tax Rate (%) |
| 2016-17 | $10 million | 27.5 |
| 2017-18 | $25 million | 27.5 |
| 2018-19 | $50 million | 27.5 |
| 2019-20 | $100 million | 27.5 |
| 2020-21 | $250 million | 27.5 |
| 2021-22 | $500 million | 27.5 |
| 2022-23 | $1 billion | 27.5 |
| 2023-24 | All companies | 27.5 |
| 2024-25 | All companies | 27 |
| 2025-26 | All companies | 26 |
| 2026-27 | All companies | 25 |
Superannuation
The Australian Government has also announced a range of major new measures to change superannuation, which is articulated as being “to provide income in retirement to substitute or supplement the Age Pension” (an objective which it is intended will be enshrined in the legislation) rather than for tax minimisation and estate planning purposes. These changes are outside the scope of this Legal Alert.
Collective Investment Vehicles
Two new collective investment vehicles (CIVs) will be introduced – a corporate CIV from 1 July 2017 and a limited partnership CIV from 1 July 2018. The CIVs will be taxed on a flow through basis and will be required to meet similar eligibility criteria as managed investment trusts, such as being widely held and engaging in primarily passive investment. Again, detail in the Budget is low. These reforms are intended to enhance the international competitiveness of the Australian managed funds industry by allowing fund managers to offer investment products using vehicles that are used overseas. That is, this change is about bringing Australia into line with international norms and weaning us away from trusts as the investment vehicle of choice.
Private companies
Australian law contains a range of measures designed to prevent tax avoidance activity between private companies and their shareholders and associates.
The Australian Government proposes to amend these rules (in particular Division 7A in the 1936 Tax Act) to improve clarity of operation. Although information remains thin, these amendments appear to include a self-correction mechanism (regarding inadvertent breaches), the introduction of a safe-harbour rule (to provide greater certainty for taxpayers, particularly in identifying arm’s length pricing) and the establishment of a simpler set of rules regarding when related-party loans need to be treated as dividends.
For further information, please contact:
John Walker, Partner, Baker & McKenzie
john.walker@bakermckenzie.com
