4 October, 2015
On 16 September 2015, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 (Bill) was introduced into Parliament for its first reading. On 17 September 2015, the Bill was referred to the Senate Economics Legislation Committee for inquiry and report by 9 November 2015, suggesting that the Bill should not be enacted at least until that date.
The Bill contains the latest iteration of Australia's multinational anti-avoidance law (MAL) (as well as the increased penalty rules and the country-by-country reporting rules), which were originally announced on 12 May 2015. The latest Bill and explanatory memorandum (EM) can be accessed here.
Importantly, the Bill has broadened the scope of the MAL, as compared to its original iteration previously contained in the exposure draft (ED) legislation released on 12 May 2015. The Treasurer's prediction that the broadened MAL could apply to 1,000 multinationals might not be too far off the mark.
Who is affected
The MAL will apply to global entities with A$1 billion or more annual global income (determined on an accounting consolidated group basis), where a foreign entity in the group makes supplies to Australian customers whilst avoiding the attribution of income to an Australian permanent establishment (pe).
Please see below Appendix 1 for a summary of the key requirements for the MAL to apply.
Please see below Appendix 2 for a summary of who should not be affected by the MAL.
How the MAL has been broadened
There are significant differences between the Bill and the ED. These differences broaden the application of the Bill to multinationals. A summary of the key differences and what it means for multinationals are set out below:
1. Removal of the "no/low corporate tax jurisdiction" test: the previous "connected with no/low corporate tax jurisdiction" test has been removed, broadening the scope of the MAL. The test now only requires the foreign entity to have either obtained an Australian tax benefit or reduce one or more of their foreign tax liabilities in connection with the scheme.
What it means for multinationals: For the MAL to apply, there is no longer a need for the foreign entity to be "connected with a no/low corporate tax jurisdiction" (though this remains a relevant consideration for the "principal purpose" test – see point 2 below). No doubt the various submissions made to Treasury, questioning how the concept of a no/low corporate tax jurisdiction is defined, would have influenced this change in approach. Also, having substantial economic activity in a no/low tax jurisdiction is no longer an automatic safe harbour (see point 4 below).
Instead, merely reducing an Australian or foreign tax liability satisfies this requirement.
2. Tightening the previous exclusion of supplies to Australian associates: the ED previously excluded supplies by a foreign resident to its associates. In contrast, the Bill now excludes supplies by a foreign entity to an entity that is a member of the same accounting consolidated group.
What it means for multinationals: Whether the Australian entity is an associate (which is essentially a majority control test) of the foreign entity is no longer relevant.
If the foreign entity is not a member of a global accounting consolidated group, supplies made to its Australian associates are still caught under the MAL.
Thus, the foreign entity needs to ensure its supplies are made to an Australian entity that is in the same accounting consolidated group (see also point 5 below regarding the extent of activities).
3. The need to look at reduction and deferral of foreign tax liabilities: whether a foreign tax is reduced (which includes deferring foreign tax liability without "reasonable commercial grounds") is also a specific factor that the Commissioner must have regard to in determining whether there is the requisite "principal purpose" of obtaining an Australian tax benefit, or obtaining an Australian tax benefit and reducing a foreign tax liability.
Multinationals need to know how each member in the entity's global accounting consolidated group is taxed in Australia and in any relevant foreign jurisdictions, as these factors will be specifically relevant in finding or disproving the "principal purpose" of tax avoidance. The country-by-country reporting documentation will be relevant (see "documentation considerations" below).
For instance, the requisite "principal purpose" may be found:
- if none of the income from the Australian sales in the entity's global group is subject to tax in any country (as seen in Example 3.7 in the EM); or
- if the structure is one that avoids an Australian pe, Australian income tax and foreign withholding tax (e.g. for royalties on intellectual property held offshore) (as seen in Example 3.9 in the EM).
4. Removal of the "designed" requirement: the ED required a scheme "designed" to avoid the non-resident deriving income that is attributable to an Australian pe of the non-resident. The Bill removed the "designed" requirement and only requires the foreign entity to derive income, some or all of which is not attributable to an Australian pe.
What it means for multinationals: The requirement is satisfied even if the structure was not "designed" to avoid attribution of income to an Australian pe. The test is instead limited solely to the "principal purpose" test.
The reference to "some or all" means that it is no defence to attribute nominal amounts of income to the Australian pe.
5. The need to look at activities that bring about the supply contract: under the Bill, in finding the requisite "principal purpose", the Commissioner must have regard to the extent to which the activities that contribute to bringing about the contract for the supply are performed, and are able to be performed, by the foreign entity, its Australian-based entity and any other entities. The ED was silent on this, though it did look at whether there was substantial economic activity in a no/low tax jurisdiction.
What it means for multinationals: A structure where the foreign entity, rather than its Australian subsidiary, undertakes substantial activities in relation to dealing with Australian customers may lower the risk of the MAL applying (see examples 3.9 and 3.10 in the EM).
However, having substantial economic activity in a no/low tax jurisdiction is no longer an automatic safe harbour. Rather, this is a specific factor that the Commissioner must have regard to, in finding a "principal purpose" of Australian/foreign tax avoidance. Logically, the more substance in the no/low corporate tax jurisdiction, the less likelihood of the requisite purpose being satisfied and thus of the MAL applying (see Example 3.8 in the EM, which concluded there should be no principal purpose where the foreign entity's employees undertake substantial activities that contribute to the conclusion of contracts with Australian customers).
6. Broadening of the threshold tests, now based on income, rather than turnover or revenue: the reference to "annual global turnover" in the ED has been replaced with the reference to "annual global income" in the Bill.
What it means for multinationals: A foreign entity will need to consider the potential application of the MAL if the annual global income (of itself on a standalone basis or of its global accounting consolidated group) is A$1 billion or more in the income year. See Appendix 1 on how "annual global income" is determined.
7. Broadening of the types of foreign entities caught by the MAL: the reference in the ED to "non-resident" has been replaced with "foreign entity", defined to include any entities that are not an Australian entity.
What it means for multinationals: Foreign vehicles such as partnerships and trusts may be caught under the MAL.
8. Broadening the concept of "Australian customers": the reference in the ED to "Australian residents" has been replaced with "Australian customers", defined to include (a) entities in Australia or (b) any Australian partnerships, Australian trusts or Australian residents who are not dual-residents under an applicable treaty tie-breaker test.
What it means for multinationals: A supply to anyone located in Australia, for example as shown by an Australian delivery address, would satisfy the requirement. There is no need to prove the tax residency of the Australian customer, if that customer is in Australia.
What happens if the MAL applies
If the MAL applies, the relevant entity may be subject to:
- Australian income tax liability, as a result of the Commissioner cancelling any Australian tax benefits obtained in connection with the scheme;
- Australian withholding tax liability, as a result of (for example) the Commissioner finding a reasonable counterfactual that comprises an Australian pe paying a royalty to an offshore intellectual property holder;
- interest; and
- increased penalties of up to 120% of the Australian income tax liability.
Generally, the Australian tax benefits cancellable under the MAL would be the non-taxation of Australian income tax that has been "saved" by not having an Australian pe or having any income attributable to an Australian pe. To this end, the EM explains that the Commissioner would readily calculate the Australian tax avoided by finding the reasonable counterfactual of a hypothetical Australian pe and applying the transfer pricing principles to attribute assessable income (and possibly allowable deductions) to that pe.
The MAL will be placed within the Australia's domestic general anti-avoidance rules. Section 4(2) of the International Tax Agreements Act 1953 (Cth) provides that Australia's domestic general anti-avoidance rules override the operation of any Australian tax treaties. This means that, if the MAL applies, the Commissioner will argue that taxpayers cannot raise any treaty defences in order to be exempted from Australian tax.
What should be done
Revisiting existing structures
Multinationals will have until 31 December 2015 to restructure their affairs if required. This should be considered also in the context of the OECD's BEPS Action Plan, which is expected to be finalised in October 2015.
Multinationals should examine their existing structures that facilitate or carry out sales to Australian customers. Possible structures that may not fall afoul of the MAL include:
reseller arrangements under which products currently supplied directly by a foreign entity to Australian customers are instead supplied to an Australian distributor in the same accounting consolidated group;
recording income derived from Australian sales/activities to a higher tax paying country, rather than no or low tax jurisdictions; and
replacing Australian operations carried out by staff or dependent agents located in Australia with operations carried out by commercially independent agents.
Documentation considerations
Multinationals should consider how its country-by-country reporting would document:
- how its entities are taxed in Australia and overseas;
- the nature and extent of activities undertaken by each entity that bring about the conclusion of the supply contract; and
- the commercial advantages of such arrangements.
- These matters will be relevant in determining the "principal purpose" of structures, which the Bill specifically requires the Commissioner to have regard to in finding the requisite tax avoidance purpose.
How Australia and its MAL fit in with the OECD's work on BEPS
Australia's role against tax avoidance and BEPS
When first announced on 12 May 2015, the MAL was intended to be the Government's immediate action against the perceived BEPS activities. By "going it alone" ahead of the finalisation of the OECD's work on BEPS, Australia intends to take a "leading role in the push for foreign businesses to pay their fair share" (see EM at 1.1).
Appropriateness of the MAL as a unilateral measure
Unilateral measures by one country could lead to the “most likely outcome” of other countries implementing uncoordinated unilateral measures, resulting in a “multitude of unilateral measures which differ, duplicate or even contradict one another” (P. Saint-Amans (OECD director for tax policy and administration), untitled letter to Senate Economics Reference Committee, dated 18 February 2015).
Furthermore, introducing a unilateral measure such as the MAL outside the OECD's multilateral framework presents risks of double taxation across different jurisdictions. These tensions are particularly significant in the context of the MAL. The MAL will purposefully form part of Australia's general anti-avoidance rules, with the objective of specifically overriding any treaty relief. The MAL places a significant focus on the reduction of foreign taxes, both as a test within the MAL and as a relevant factor which the Commissioner must have regard to in finding the requisite principal purpose of tax avoidance. Also, the EM demonstrates Australia's assertion of taxing rights on amounts "shifted" offshore – by possibly imposing Australian income tax and withholding tax on a hypothetical counterfactual of a notional Australian pe (as discussed above). This may lead to competing interests by Australia's treaty partners, who may also assert taxing rights as the resident country of the taxpayer's, placing significant strain on their foreign tax offset regimes.
What's next
A raft of complementary measures are in line for application in Australia, such as Australia's proposed implementation of the OECD's country-by-country reporting regime and Common Reporting Standard for automatic exchange of financial account information. The reform is ongoing, with the Senate Economics References Committee recommending in August 2015 a number of tax transparency measures that aim to expose evidence of tax avoidance.
Appendix 1: A summary of key requirements for the MAL to apply
The requirements for the MAL to apply are:
- a foreign entity makes a supply to its Australian customer. "Supply" has its meaning adopted from the Australian goods and services tax legislation and thus encompass most sales of goods and services (including intangibles) to Australian customers. However, "supply" excludes the supply of equity interests, debt interests and options to supply such interests (see Appendix 2 for more detail). "Australian customer" excludes entities that are members of the foreign entity's accounting consolidated group (the supply test). Thus, supplies by a foreign entity to an Australian subsidiary within the same accounting consolidated group should be excluded from the MAL (see Appendix 2 for more detail);
- activities are undertaken in Australia directly in connection with the supply (the Australian activities test);
- some or all of those activities are undertaken by an Australian entity who is an associate of or is commercially dependent on the foreign entity, or undertaken at or through an Australian pe of an entity who is an associate of or is commercially dependent on the foreign entity (the associate/dependence test);
- the foreign entity derives ordinary income, or statutory income, from the supply (the income test);
- some or all of that income the foreign entity derives from the supply is not attributable to an Australian pe of the foreign entity (the non-attribution test);
it would be concluded that the person/s entered into or carried out the scheme for a principal purpose of, or for more than one principal purpose that includes a purpose of, avoiding Australian tax or avoiding both Australian tax and a foreign tax (the principal purpose test). This is an untested threshold modelled based on the OECD's proposed anti-treaty abuse rule, and is intended to be a lower than the "sole or dominant purpose" threshold in Australia's general anti-avoidance rules; and the foreign entity is a "significant global entity" (i.e. one with "annual global income" of A$1 billion or more) for the income year in which a taxpayer would obtain an Australian tax benefit or reduce one or more of their foreign tax liabilities (the Australian or foreign tax avoidance test).
"Annual global income"
"Annual global income" is the total annual income of all the entities in an accounting consolidated group. Total annual income is that as shown in "global financial statements" or, if there is no such statements, the Commissioner's reasonable estimate of the total income. "Global financial statements" are those prepared and audited in accordance with accounting and auditing principles or those that give a true and fair view of the financial position and performance of that entity.
The accounting consolidated group is determined by reference to accounting principles, with the head entity being an entity that is not "controlled" by another entity.
The annual global income is determined each relevant income year in which the foreign entity or another entity would have obtained the Australian tax benefit. The definition can apply in one year but not in another year, depending on the taxpayer's annual global income.
The amount of income must be converted into Australian currency based on the average exchange rate for the period for which the statements are prepared.
Appendix 2 – A summary of who is not affected
The Bill and the EM, as currently drafted, suggest that the MAL should not apply to the following:
supplies by foreign entities to another Australian member of their global accounting consolidated group. As Example 3.1 in the EM illustrates:
Example 3.1: Supply made by foreign entity through an Australian subsidiary
A foreign entity sells goods to its Australian subsidiary. The Australian subsidiary then sells the goods to unrelated Australian customers. The income from Australian customers is recognised for tax purposes by the Australian subsidiary.
Because the foreign entity is supplying goods to a related Australian subsidiary, the multinational anti-avoidance law will not apply.
supplies by foreign entities in certain fly-in, fly-out arrangement. As Example 3.4 in the EM illustrates:
Example 3.4: ‘Fly-in, fly-out’ arrangement
A foreign entity that sells large highly specialised machinery has no associates in Australia and does not have an Australian permanent establishment.
In order to sell machinery to Australian customers, the foreign entity flies two of its employees to Australia for a week to meet with and understand the needs of Australian customers. The foreign entity’s personnel then fly back to the host country to incorporate the information obtained from the meetings in Australia into the development of their product and offering. The arrangement is such that the two employees visiting Australia do not otherwise amount to a permanent establishment in Australia.
The Australian customer purchases the goods directly from the foreign entity. There is no other connection with Australia in relation to the arrangement.
Because there is no Australian entity, or entity in Australia, assisting with the sale, the multinational anti-avoidance law does not apply.
supplies by foreign entities through an "commercially independent" agent. The EM at 3.45 states that an entity would be commercially dependent if they are, in substance, reliant on the foreign entity for their business to operate. Thus, as Example 3.6 in the EM illustrates:
Example 3.6: Entity that is not commercially dependent
A foreign entity supplies services to Australian customers through a legally independent agent.
The agent has a diversified business and acts for multiple foreign suppliers. As such, it is not commercially dependent on the foreign entity’s business and the multinational anti-avoidance law does not apply to this arrangement.
foreign entities selling equity interests, debt interests or options in such interests to Australian customers. The EM at 3.36 explains that this is to prevent unintended consequence of capturing the legitimate structures of offshore capital market participants including foreign investors in Australian shares and debt interests. As Example 3.2 illustrates:
Example 3.2: A supply made by foreign entity to Australian customers
A foreign entity sells shares in an Australian company to the Australian public through an Initial Public Offering (IPO).
As the supply to Australian customers is a supply of shares, which are equity interests, this would not be a supply that would be caught under the multinational anti-avoidance law.
supplies by Australian entities (regardless of their global annual income) to Australian customers. The MAL only applies to supplies by foreign entities to Australian customers. "Australian entity" is defined to include an Australian partnership, Australian trust and Australian residents (who are not dual-residents under a treaty tie-breaker rule).
For further information, please contact:
Kenny Mui, Baker & McKenzie
kenny.mui@bakermckenzie.com
