9 May, 2018
This Bulletin outlines the key Australian income tax developments in the last month affecting your business, including new legislation to implement the "Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting".
Top 5 developments in tax this month you need to know
What you need to know
The Government has introduced into Parliament the Treasury Laws Amendment (OECD Multilateral Instrument) Bill 2018 (Bill) to implement the "Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting" (MLI).
The MLI, a key component of the OECD's "Base Erosion and Profit Shifting" (BEPS) project, will modify the operation of the majority of Australia's double tax agreements (DTAs) to give effect to the recommendations of the BEPS project.
The MLI, amongst other things, contains a range of anti-avoidance measures that will need to be consulted in addition to existing DTAs and domestic anti-avoidance laws.
Accordingly, once implemented, taxpayers will need to consult both the DTA and the MLI as well as domestic law to work out the relevant Australian tax implications of arrangements with most of our treaty partner countries.
In October 2015 the OECD and G20 published their BEPS report. The BEPS report contains recommendations for 15 "action items" designed to target different types of tax-avoidance behaviour by international entities.
One of these actions included implementing an MLI to establish a framework to limit base erosion and profit shifting through the modifying existing bilateral DTAs.
Although the purpose of the MLI can be easily stated, the scale of the task to implement an MLI should be understated. The OECD has estimated that there are some 3,000 bilateral DTAs currently in existence and Australia is a party to 44 such DTAs. The task of drafting, negotiating and implementing a MLI modifying these DTAs with (according to the OECD) the involvement of 103 jurisdictions in the negotiations is an immense undertaking.
The key aspects of the MLI and how it affects Australian taxpayers are summarised below.
What does the MLI cover?
There are 3 key aspects to the MLI.
First, the MLI targets a range of tax avoidance activities identified in the BEPS action items, including (but not limited to) the following:
- the use of "fiscally transparent entities" for tax avoidance purposes;
- the use of "dual resident entities" to shift profits from one jurisdiction to another for tax minimisation purposes;
- "treaty shopping" (whereby interposed entities without economic substance may be located in the most favourable tax treaty jurisdiction to reduce taxes); and
- the artificial avoidance of permanent establishment (PE) status through either specific activity exemptions or contract splitting to ensure the relevant activities fall out of PE status.
Second, the MLI includes a number of provisions to avoid double taxation outcomes, such as requiring jurisdictions to credit foreign tax imposed on the income of an entity when calculating the entity's tax obligations in the other jurisdiction and requiring downward compensating adjustments to be made for upward transfer pricing adjustments by a treaty partner country (provided both countries agree that the upward adjustment is justified).
Third, the MLI incorporates a dispute resolution mechanism through mandatory binding arbitration if parties cannot reach agreement on a case presented by a taxpayer through existing DTA "mutual agreement procedures" (MAP).
How significant are the changes?
From an Australian perspective, many of the anti-avoidance aspects of the MLI are already, or are in the process of being, dealt with through separate specific anti-avoidance measures. This includes the existing "multinational anti-avoidance law" (which deals with artificial PE avoidance), the proposed anti-hybrid rules (which deals with various transactions involving fiscally transparent entities) and the general anti-avoidance provisions in Part IVA (which, for example, have been used to deal with "treaty shopping").
The MLI will add an additional layer of complexity by providing an extra set of anti-avoidance rules that will need to be consulted in addition to, and not in place of, many of these exiting rules.
Australia will not adopt the provisions of the MLI relating to the relief of double taxation (on the basis that all of Australia's treaties already apply the credit method in relieving double taxation) but will adopt the provisions regarding compensating transfer pricing adjustments. However, we do not expect this change to be particularly significant given the existing MAP procedures in Australia's DTAs for resolving bilateral transfer pricing disputes.
In relation to mandatory binding arbitration, historically, where a taxpayer submitted a DTA issue to a MAP process, and the relevant revenue authorities could not reach agreement to resolve the issue, there was no further recourse for the taxpayer, which usually lead to a double taxation outcome. Further, the MAP process was often lengthy, without any prescribed rules or regulations for resolving matters.
Mandatory binding arbitration is therefore a welcome addition to the international tax framework, as it may allow unresolved MAP issues to be determined in a binding process by an independent and impartial arbitration panel.
How does the MLI work?
As noted above, the MLI will, where certain conditions are satisfied, operate to modify existing DTAs by transposing relevant integrity recommendations in the BEPS final reports into the DTA.
However, working out how the MLI modifies existing DTAs is no simple task, because the MLI allows parties to make a number of different choices as to how the MLI will modify their DTAs and different countries can make different choices and add different reservations.
In light of this, the task of working out how the MLI modifies a DTA can be broadly summarised as follows:
- Determine if the DTA partner is a party to the MLI. For example, at the date of writing, the Unites States is not a party to the MLI. Therefore, the MLI has no impact on the Australia-US DTA.
- Determine whether the parties' relevant choices and reservations under the MLI align. If they do not, then the provisions in the DTA will apply unaffected by the MLI.
- If the parties' relevant choices and reservations under the MLI align, apply the provisions in the DTA as modified by the parties' MLI choices and reservations.
The OECD is developing a Toolkit for Application of the Multilateral Instrument to facilitate taxpayers applying the MLI according to this process.
Application
There are a number of procedures that need to be followed before the MLI can affect the operation of Australia's DTAs.
As a first step, the MLI needs to be ratified by Australia. Passage of the Bill is part of this ratification process. Once Australia has ratified the MLI, it enters into force for Australia on the first day of the month following three months after the date of deposit of Australia's instrument of ratification with the OECD. The date on which the provisions of the MLI take effect is also contingent upon the completion by the relevant DTA partner jurisdiction of their own domestic ratification processes.
The MLI affects the operation of Australia's DTAs with respect to:
- withholding taxes – for amounts paid or deemed to be paid on or after 1 January occurring on or after the later date of entry into force of the MLI for Australia and its relevant partner jurisdictions; and
- other taxes – for taxable periods beginning on or after six months after the later date of entry into force of the MLI and its relevant partner jurisdictions.
Overall, this means that the MLI will take effect for different DTAs at different times, adding to the overall complexity of the MLI analysis. Further, there is no grandfathering for exiting arrangements, which will also be subject to any DTA modifications effected by the MLI.
Comments
The MLI will have significant implications on the operation of Australia's DTAs which, in turn, will significantly affect taxpayers' existing and future cross-border arrangements.
Taxpayers should have regard to the MLI when putting cross border transactions and structures in place and should also check the impact of the MLI on any of their existing arrangements.
For further information, please contact:
Vivian Chang, Partner, Ashurst
vivian.chang@ashurst.com
