It is ‘silly season’ in Australia at present – that twilight period ahead of the release of the annual Federal Budget, scheduled this year for Tuesday, 12 May 2015. The media is, as usual, awash with speculation regarding what is ‘hot’ and what is ‘not’ in the world of tax.
The most recent media speculation about potential changes to Australia’s corporate tax system – apparently based on solid inside knowledge – is twofold. First, Treasurer Joe Hockey has given up the idea of introducing an Australian ‘Google tax’ - sensible move, Mr Treasurer.
But do not breathe easy too quickly. The government is expected to legislate for trial by public opinion – the ‘Starbucks effect’, referring to the public strike against Starbucks in the UK in 2012 when it was revealed the company paid no UK tax despite generating significant revenues from UK coffee sales. If this speculation proves to be accurate, it will be a remarkable capitulation to populism by a conservative government.
‘Google tax’ off the agenda
As is well known, the OECD/G20 base erosion and profit shifting (BEPS) project aims to reinvent the international tax framework and make it relevant to the digital economy. That process is drawing to a close, and the global consensus approach is increasingly under pressure. The UK broke first, with the unilateral introduction of its diverted profits tax (DPT), dubbed the ‘Google tax’, introduced by the conservative government in the lead up to the 7 May general election. (As we read this alert, that move may prove to be the difference between Mr Cameron’s government being returned, or not.)
Despite being treasurer during Australia’s G20 presidency year (replete with public commitments to co-ordinated global action on BEPS), Mr Hockey changed tack some weeks back and seriously proposed the introduction of an Australian Google tax. After much confusion and speculation about how such a tax could be introduced in Australia without breaching its international treaty commitments, Mr Hockey softened the rhetoric and instead indicated Australia was working closely with the UK, exploring joint action, and how a DPT may be applied in Australia.
Apparently the government’s position has changed yet again - the latest media reports call the Google tax option as dead. But do not expect the Australian Government to sit back and await the global outcome of the BEPS process. It faces a general election in about 18 months’ time, and is well behind in the public opinion polls – getting tough on multinational tax planning seems to be flavour of the month, and another ‘rabbit’ Australia has imported from the UK.
Taxation by public opinion
Those same media reports, quoting informed sources, foreshadow the introduction in next week’s budget of a revolutionary and unique transparency regime. This new disclosure regime will be in addition to be existing tax disclosure regulations, and will be different to the BEPS Action 13, country by country reporting (CbCR) requirements.
The new regime will mandate Australian corporate groups, and global multinational corporate (MNC) groups operating in Australia, to calculate and publicly disclose the effective tax rate (ETR) payable on profits derived from Australian related activities. (We anticipate it will only be the ETR which is to be publicly disclosed – not the underlying calculations.) This initiative will not change the actual calculation of Australian tax payable, but will subject to public scrutiny the effective Australian tax, and global tax, burden applicable to Australian-linked profits.
Effective Tax Rates (ETR)
The concept of the ETR has been around for a long time. It is a ratio between tax and a base consisting of income, revenue or profit. There is no single commonly accepted formula for calculating an ETR – there are many different measures of ‘tax’, and there are many different measures of income, revenue or profit.
Recently, before the Senate Economic References Committee enquiry into corporate tax avoidance, testifying corporations quoted ETR’s to demonstrate the high level of Australian tax paid. There was no consistency in the basis of calculating these ETR’s and the ATO was critical of some of the methodologies adopted.
The ATO indicated to the senate enquiry it had developed a formula for calculating an ETR which, if applied to the testifying corporations, would permit a comparison on a ‘like for like’ basis. The ATO subsequently provided the enquiry with the formula, and apparently the Enquiry is considering whether or not to recall the testifying corporations to require them to apply the ATO formula and disclose the effective ETR which results.
It is this ATO formula which the media reports indicate will be legislated next week. If the reports prove accurate, Australia will be out on its own, and the government’s ‘open for business’ mantra will take another battering.
The ATO formula – (1) Australian-linked profits
The ATO formula has a number of variants, as it needs to apply to Australian groups operating domestically; Australian groups operating globally and MNCs operating into Australia.
The core objective is to quantify revenue, income or profits which are related to Australian-linked business operations; to quantify taxes paid on that Australian-linked revenue, income or profits; and from those two figures, determine the Australian or global ETR.
This formula has nothing to do with existing concepts of tax jurisprudence – source and residence is irrelevant; intermediate company structures are totally disregarded; the focus is on income or revenue which is generated from Australian-linked business operations, whether earned by Australian companies or by overseas companies.
The actual approach adopted in the formula is to start with the Australian accounting profit (always assuming there is an Australian company involved), and then add back all payments made to international related parties. Also added, would be revenue from Australia derived directly by international related companies. (This would catch the Google and Microsoft business structures, amongst others.)
Deductions would be allowed for payments made to unrelated third parties for goods and services supplied in the generation of the Australian-linked business income. This would include payments made by the Australian company itself (e.g., to employees, to contractors, and to other unrelated service providers), and payments made by companies through the international related party value chain to their third party suppliers.
Whilst the formula operates differently, the result is very similar to the first step of a global formulary apportionment calculation, although in this case focused only on Australian-linked business revenue. Consider the MNC as a single global tax payer, deriving gross revenue from its Australian operations. From that gross Australian revenue, deduct only those payments made to third-party service providers – disregard all payments made to related parties within the consolidated group. The result is the profit attributable to the Australian-linked business operations.
The ATO formula – (2) tax paid
The second component is the calculation of the relevant tax. The formula focuses on ‘tax paid’ within an income year, and that disregards accounting concepts, tax accrual calculations, or any other measurement of tax.
Where payments subject to Australian withholding tax have been added back and included in the profit calculation above, then Australian withholding taxes paid would be included in the ‘tax paid’ base.
Any foreign taxes paid on the Australian-linked profits as those profits pass through the MNC group, would be included in the Australian ‘tax paid’ base. To the extent foreign taxes along the value chain are low, or non-existent, then no amount would be included in the Australian-linked ‘tax paid’ base.
If an Australian subsidiary derives Australian-linked profits; makes no international related party payments; pays tax at 30% on its Australian taxable income; and distributes the after-tax profit by way of dividend to its foreign parent, the ETR will be 30%.
If an Irish or Singaporean group company generates (untaxed) revenue from within Australia by way of the remote (from Australia) provision of intangibles or services; a related Australian subsidiary provides limited ‘routine’ services within Australia for a service fee from the related international sales companies; then the sales revenue generated from Australia by the Irish/Singaporean sales companies will be added to the accounting profit of the Australian subsidiary. (Presumably the Australian subsidiary’s group revenue would be excluded.) If little or no tax was paid through the value chain, other than the Australian tax paid by the Australian subsidiary, then the formula ETR would be very low, notwithstanding that the ETR for the Australian subsidiary, calculated on a stand-alone basis may be 30%.
The Australian-linked profits can be reduced by interest expenses but only to the extent of the group’s global average level of third party borrowing (average debt load at average rate). The Labor Party policy includes a similar proposal, which was decried by the government just a few weeks back. (A week can be a long time in politics…)
No deductions are allowed for group FX gains/losses, derivatives, insurance premiums, etc.... unless there is a back-to-back arrangement with an unrelated third party, in which case a pro rata of those third party costs could be set off against the Australian-linked profits.
Is this just another thought bubble? The OECD agonised over the type of information to be required in its country by country reporting requirement, and then limited its application to only MNC groups with turnovers exceeding Euro 750m. For those affected, the first CbCR will be required for the year commencing 1 January 2016, with the actual report not due before 31 December 2017.
This threshold and the lead-time for reporting, allows the largest corporate groups time to put in place the necessary systems and reporting protocols to be able to comply with the requirements.
Whilst we have the outline of a formula for the ETR proposal, there is nothing whatsoever to indicate how this information is to be acquired, nor at this point when the reporting may commence. And crucially there is no indication of any de minimis turnover level for the application of the new regime.
Other transparency measures
The BEPS Action 13 CbC reporting initiative is closest to this ETR proposal, but that information is to be kept confidential amongst revenue authorities – it is not to be made public and it is not to be used as the basis for assessing tax liabilities of any company within an MNC group.
The ETR proposal may not actually release any specific information to the public, but presumably the process by which a company calculates its ETR will be subject to audit by the ATO. The information would be similar to, if not the same (in substance) as that required under the CbC reporting regime, but without the benefit of the Euro 750m threshold.
And then there is the existing Australian disclosure regime, legislated by the previous Labor government. That imposes an obligation on the ATO to publicly disclose certain tax information about companies with a turnover of $A100m or more.
The information is:
- company name/ABN
- total income
- taxable income
- tax payable
The present government suggested early in its term that this measure should be repealed entirely, but in the end it was left in place for public companies, but private companies will be exempted. And now we seem to have the same government proposing an even more demanding transparency regime.
No change to the calculation of tax
A final point of emphasis – the introduction of the formula ETR disclosure, if it does materialise, will not change the process of actually calculating a taxpayer’s Australian tax liability. However, where an MNC discloses a low ETR, it can expect in addition to close ATO attention, public obloquy and reputational risk a la Starbucks.
All large corporate taxpayers should await next Tuesday’s budget with great interest.