On 29 November 2016, the Australian Treasury released an exposure draft of the proposed Australian version of the Diverted Profits Tax (DPT), together with an explanatory memorandum. The consultation period for the draft legislation closes on 23 December 2016.
The DPT will apply from 1 July 2017, at the rate of 40%, and will complement the Multinational Anti Avoidance law (MAAL) which has been in operation since 1 January 2016. Both measures aim to stop profit-shifting out of Australia. Both measures carry penal rates of tax, and the Government’s intent is to ‘encourage’ affected taxpayer groups to restructure their operations into and with Australia in order to align tax outcomes with economic substance, rather than to collect the tax at the higher rate.
What arrangements are targeted?
The DPT will apply where:
- There is a scheme between parties, and it is reasonable to conclude the scheme was carried out for a principal purpose of obtaining a tax benefit for one or more Australian taxpayers, or a tax benefit together with a reduction in a taxpayer’s foreign tax liabilities, ie. Australian profits are ‘diverted’ overseas;
- The taxpayer is part of a global group with an annual global turnover in excess of $A1Bn (ie, it is a ‘Significant Global Entity’ – SGE);
- There is a non-Australian associate of the Australian taxpayer, and the associate was involved in the scheme to any extent.
Despite all these positive requirements being satisfied, the DPT will not apply to an arrangement if any one of the following ‘exit’ provisions apply:
- The de minimus income test: the potentially targeted Australian turnover is less than $A25 million;
- The de minimus tax benefit test: the foreign tax payable on the diverted Australian profits equals or exceeds 80% of the Australian tax that would have been payable on those profits had they not been ‘diverted’;
- The economic substance test: the arrangements between the Australian and associated foreign companies satisfy the transfer pricing rules for economic substance, and the tax liabilities align with that economic substance.
How will the DPT apply?
This is where tax norms are inverted, and visions of the ‘Star Chamber’ are conjured. The power is all with the ATO – and that is intentional. The ATO can issue a DPT assessment in cases “where it is reasonable to conclude that profits have artificially been shifted out of Australia”.
The ATO can do this based only on “limited information”, and whilst we would expect the ATO would not act capriciously, the way in which this ambit power is exercised, will be a matter for close attention.
Pay now, argue later
Where a DPT assessment is issued, a taxpayer must pay the assessed tax liability within 21 days; there is no opportunity at this point to object against the assessment.
There follows a 12 month review period within which the taxpayer can provide arguments and evidence to the ATO in support of contentions that the DPT is inappropriate, or excessive. In practice, those arguments will be directed towards the 3 ‘exit provisions’ and as the $A25 million turnover test should be self-evident, and the ‘sufficient foreign tax’ test should also be relatively straight toward, it might be expected the focus will be on the ‘sufficient economic substance’ test.
That test is all about transfer pricing rules, and the appropriate application to the particular circumstances. Where a taxpayer had appropriate contemporaneous transfer pricing documentation in place at the time the DPT assessment was issued, it seems circular to consider the matter stands to be determined (post payment of the assessed DPT liability) by reference to that same transfer pricing documentation.
The explanatory memorandum indicates the DPT is intended to change (recalcitrant) taxpayer behaviour, so its use would be appropriate where taxpayers do not comply with information requests, or are otherwise non-cooperative. This could be understood, and in that context the DPT could be seen as a measure of last resort. Unfortunately, none of these concepts or limitations appear in the legislation, and the ATO is notorious for cherry-picking explanatory memoranda guidance.
Consider any large multinational tax case, where the tax is significant, the issues multifarious and complex, and the ATO is falling behind its own performance management timelines, but the taxpayer is engaged in the process in good faith. There is no legislative bar to the ATO issuing a DPT assessment in those circumstances to ‘move things along’. And that may well include a case where the taxpayer holds complying contemporaneous documentation.
Limited objection and review processes
An aggrieved taxpayer can object to a DPT assessment, but only at the conclusion of a 12 month review period from the issue of the DPT assessment. In those proceedings, the taxpayer is limited in the evidence that can be adduced, and cannot enter any documentary evidence that was available to the taxpayer during the review period, but was not provided to the ATO during the review.
Where does the DPT fit in the tax jigsaw?
The DPT could be seen as being thrust into an already crowded playground. The legislative target is the diversion of profits from Australia, with the consequent loss of Australian revenue. But that is the same target of the transfer pricing rules, which as we know have only recently been rewritten to what we are told now represent ‘world’s best standard’.
And then we have the MAAL. And we are nearing the implementation of the treaty-related BEPS measures through the signing of the multilateral convention. And we have the queue of domestic BEPS changes still to come.
Carving out a clear need or role for the DPT is a challenge, and the anecdotal evidence from the UK is that HMRC has been very slow to ‘pull the DPT trigger’, if in fact it has at all. But an even greater challenge is understanding how all these new measures will coalesce in practice. Are we facing a trifecta – transfer pricing, MAAL, DPT – overlaid with the patina of BEPS? The compliance costs and confusion of navigating all these new provisions will be significant – and these are only the Australian provisions, with Australia accounting for something like 2% of global GDP. The Government can talk up the need for a reduction in the headline corporate tax rate, but any politically achievable minor rate reduction is likely to be offset by the costs of complying with these new rules. What then the overall effect on inbound investment flows?
We await with interest the ATO’s future guidance on the DPT (presumably a further Law Companion Guide?), but in the meantime, multinational taxpayers need to revisit their existing international arrangements; consider the strength of their existing or planned transfer pricing documentation; and if necessary, explore possible restructure options ahead of 1 July 2017.
For assistance in divining a way through this morass, please contact your local RSM tax adviser.