In introducing the ‘Combating multinational tax avoidance’ bill to the Australian Parliament on 16 September 2015, the government has taken another unilateral step in its fight against international base erosion and profit shifting (BEPS). The new bill contains three changes, all of which have been the subject of earlier exposure draft legislation. Opposition is not expected, so the bill should be fast tracked through the legislative process.
The bill contains provisions:
- to extend the general anti avoidance rule (Part IVA) to cover business structures which artificially avoid an Australian permanent establishment, and shift otherwise Australian sourced revenues offshore
- to double the penalties for such ‘egregious’ multinational tax avoidance
- to write into domestic tax law the requirement to comply with the OECD’s Action 13 Report on country-by-country reporting, master file, and local country file reporting
Urgent action required
These measures will apply only to taxpayer groups with global revenues exceeding $1bn. But affected companies have only until 1 January 2016 – three short months – to determine whether their existing business structures may be at risk, and if so, what remedial action to implement.
This will be particularly important for taxpayers who have to report uncertain tax positions, either for accounting purposes or in connection with tax return lodgements.
Who is affected?
Only large multinational groups are subject to the three proposed changes. A new ‘centralised concept’ has been defined to identify those large multinational groups which will be subject to the new requirements (and the further BEPS related domestic tax changes expected to follow).
‘Significant global entity’ (SGE) is the new concept, and it is based on global annual revenue. The starting point is to identify the global parent entity of a multinational group. This could be a single entity, or could consist of two or more accounting consolidated ‘parent companies’.
By reference to the latest ‘global financial statements’, determine the group’s annual global income. This will need to be translated into $AUD, and where the figure exceeds $1bn, the global parent entity and all its controlled subsidiaries will be (collectively) a ‘significant global entity’ to which each of the three proposed changes will apply.
Where a global group does not prepare consolidated accounts, the ATO has the power to ‘determine’ that a particular group is an SGE, based on available information.
An SGE (including all of its Australian subsidiaries, and permanent establishments) will be subject to the following three amending provisions.
1. Multinational anti-avoidance law (MNAAL)
This is the Australian equivalent of the UK’s diverted profits tax (DPT) and whilst the mechanics are very different, the Australian version shares the ‘carrot and stick’ approach of the DPT. The Australian Tax Commissioner has said he hopes to raise no revenue through the new measure because global groups will restructure and voluntarily report their Australian sourced revenues, and pay Australian tax on the resultant profits.
The Australian approach is to add a new provision to Part IVA, Australia’s general anti-avoidance rule (GAAR). By this form of amendment, there is no doubt Australia can override its existing double tax treaty commitments, at least at law, if not ‘politically’.
The new provision (section 177DA) targets global groups that avoid an Australian taxable presence by undertaking significant activities in Australia with a direct connection to Australian sales, but where the sales revenue is booked overseas; and do so with a principal purpose of avoiding tax in Australia, or avoiding Australian tax and reducing a foreign tax liability.
The new section 177DA will apply where:
- There is a BEPS scheme
- The principal purpose test is satisfied
- The foreign entity is a significant global entity
A) BEPS Scheme
There are 5 requirements for a BEPS scheme:
- a foreign entity makes a supply to an Australian customer of the foreign entity
- activities are undertaken in Australia directly in connection with the supply
- some or all of those Australian activities are undertaken by an Australian entity or Australian permanent establishment (PE), either of which are associated with or commercially dependent upon the foreign entity
- the foreign entity derives income from the supply
- some or all of that income is not attributable to an Australian PE of the foreign entity.
B) Principal purpose test
Part IVA is based around a ‘purpose test’: for the existing GAAR to apply, obtaining a tax benefit from the scheme must be the ‘sole or dominant purpose’ of a relevant person.
The new section 177DA has a lower threshold: the purpose of a relevant person need only be the ‘principal purpose’, or where more than a single purpose exists, one of those purposes is a principal purpose. This lower threshold is consistent with the ‘principal purpose test’ which is to be introduced into international tax law through the OECD BEPS Action 6 Report – stopping tax treaty abuse.
The purpose test threshold is also broadened as well as lowered: currently, the GAAR applies only where the sole or dominant purpose is to avoid Australian tax. The new rule will apply where the principal purpose is to avoid Australian tax, and also to reduce any foreign tax liabilities.
The extension of the principal purpose test to include a reduction in foreign tax liabilities is notable and reflects the reality that in many instances the quantum of Australian tax avoided (the ‘tax benefit’) will be small in the context of a global group’s operations. A small tax benefit would put at risk the purpose test, even under the reduced threshold ‘principal purpose test’.
For the new provision to apply, there must be at least some Australian tax avoided, but the principal purpose test will be met where there is in addition a purpose to reduce foreign tax liabilities. But the new provision will only tax the Australian tax benefit, not the reduction in any foreign tax liabilities.
C) SGE requirement
The new MNAAL will apply only to a taxpayer which is a member of a multinational group which is a significant global entity.
If the proposed section 177DA applies, the likely response will be for the foreign entity to be attributed with a notional permanent establishment in Australia. Sales revenues would be attributed to that notional PE, and deductions allowed as appropriate. Australian tax would be payable on the profit, together with penalties (see comments below).
Deductions for royalties may be appropriate in the context of a notional permanent establishment, but royalty withholding tax may also be a further possible tax cost.
New section 177DA will apply from 1 January 2016. There is no ‘grandfathering’ protection, it is irrelevant that a particular business model has been in operation for a number of years.
However, it is only Australian tax avoided from 1 January 2016 that is at risk. Tax benefits obtained prior to the start date will be unaffected - but see comment below regarding section 177D.
OECD Action 7 Report
The G20/OECD BEPS Project has addressed in detail the issue of artificial avoidance of permanent establishments. This report is due to be released in October 2015. Many of the abuses identified in the discussion drafts of the Action 7 Report will be relevant in the context of the proposed section 177DA. But the Action 7 Report focuses on the international tax law aspects whereas section 177DA has an Australian domestic focus.
Section 177D – ‘standard’ part IVA GAAR
The proposed section 177DA will operate in addition to the existing Part IVA provisions, including in particular, section 177D.
SGEs considering their responses to the new section 177DA post 1 January 2016, must also consider whether the existing section 177D could be applied against any ‘tax benefits’ arising before that date. For the reasons noted above, it may be difficult for the ATO to satisfy the more stringent requirements of section 177D (obtaining the (possibly relatively small) Australian tax benefit must have been the sole or dominant purpose of a relevant taxpayer) but it is a matter for consideration.
Room to manoeuvre – but move quickly
In light of the short time to the 1 January 2016 start date, the ATO has indicated it will work with potentially affected SGEs to ‘understand’ the implications of unwinding current arrangements, and commencing to report more revenue in Australia.
Earlier in 2015, in response to the UK’s Diverted Profits Tax, Amazon Europe announced a restructure, with its UK sales revenues to be declared and taxed in the UK, rather than Luxemburg. The ATO and the Australian Government are expecting the MNAAL to drive similar voluntary restructures.
2. Doubling the penalty rate
Where the new section 177DA applies and a tax benefit is identified – typically where Australian sourced profits attributable to a notional permanent establishment have been shifted overseas – there will be a primary Australian tax liability to pay.
The existing penalty regime applies a 50% penalty to tax avoidance schemes (25% if a reasonably arguable position is maintained) before taking into account aggravating/mitigating factors. For profit shifting schemes (sole or dominant purpose not present) the penalty rate is 25% (10% with a reasonably arguable position).
The new penalty regime doubles the respective penalty rates – from 50% to 100%, and from 25% to 50% respectively – but leaves the reasonably arguable position rates unchanged in recognition of the high level of uncertainty in this area of the law.
The significant increase in potential penalty rates aims to increase pressure on SGEs to review their present arrangements and to return Australian soured revenues to the Australian tax net.
3. Country-by-Country Reporting, and more
The bill will give Australian domestic tax law effect to the OECD’s Action 13 Report. SGEs (but only SGEs) will need to prepare and lodge with the ATO:
- a country-by-country report (CbCR)
- a master file
- a local country file (for Australian consolidated groups, entities, or permanent establishments)
The primary obligation is on all SGEs to prepare and lodge the information in the ‘approved forms’. However, the Commissioner is given power to exclude (or include) certain entities or classes of entities from the lodgement obligation.
In this way, an Australian resident and headquartered SGE would have to file a CbCR for the global group; a master file and a local file for its Australian operations. However, an Australian resident subsidiary would be expected to lodge only a local file, provided its foreign SGE parent lodged a CbCR and master file with the relevant foreign revenue authority, and that information was exchanged with the ATO.
In a move which appears at odds with the OECD’s Action 13 process, the Australian obligation to prepare and lodge those three documents is in addition to the present obligation to prepare contemporaneous documentation on international related party transactions for all taxpayers. A major issue throughout the Action 13 deliberation was the need to streamline transfer pricing documentation required from business, and specifically to avoid an outcome where the information requirements of each Revenue Authority were aggregated, rather than agreeing on what information should reasonably be sufficient for purpose.
Australia seems to have taken the worst possible route – it requires the preparation of the standard transfer pricing documentation, and in addition requires preparation of the master file and local country file. (The CbCR was always going to be an additional separate report).
This duplication of business effort is dismissed by the government on the basis that SGEs are sophisticated organisations, and they can calibrate their systems to provide the required information without undue cost or inconvenience.
(The practical reality is the ATO has ‘outsourced’ to SGEs the cost of preparing the data in a format which can be exchanged by the ATO with participating revenue authorities.)
At least it is pleasing to see the Australian legislation adopts the information requirements already mandated by the G20/OECD in its Action 13 guidance. This will assist all business – whether Australian resident or otherwise – to clearly understand and satisfy the ATO’s information requirements.
Reasonably arguable position
Under Australia’s existing transfer pricing laws, if a taxpayer does not hold adequate ‘contemporaneous documentation’ by the time the relevant tax return is lodged, it cannot argue that it has a reasonably arguable position, in the event of an audit adjustment.
Failure to prepare/or lodge on time any of the three new ‘approved forms’ will not affect a taxpayer’s ability to maintain it has a reasonably arguable position, provided always that it otherwise holds adequate contemporaneous documentation.
The requirement for an SGE to prepare and lodge a master file, a local country file and CbCR, applies to all income years commencing on or after 1 January 2016. This would cover the 2016 calendar year for 31 December year end groups, and the July 2016 – June 2017 fiscal year for Australian resident groups.
The ‘approved form’ reports must be lodged with the ATO within 12 months of the end of the income year to which they relate. For SGEs in their first reporting year, it is expected an additional lodgement extension will be granted.
The Treasurer gave an update on other measures of relevance as part of the parliamentary speech accompanying the introduction of the bill.
- Legislation to implement the ‘Netflix’ tax (extending GST to all intangible and tangible low value imports) will shortly be introduced into parliament
- BEPS Action 2 (hybrids) is currently being considered by the Board of Taxation, with a report to government expected to follow
- The ATO is well advanced in updating its systems to comply with the common reporting standard (CRS) for automatic exchange of information (AEoI), and these mechanics are likely to form the basis for further information exchange requirements mandated by the G20/OECD BEPS project
- The ATO is working on the internal procedures to exchange with other participating Revenue Authorities its own rulings on preferential tax treatment of global taxpayers
- BEPS Action 6 ‘Prevention of tax treaty abuse’ is now being introduced into Australia’s tax treaty practice
- The Board of Taxation is developing, in consultation with business, a voluntary code for the disclosure of tax information on a consistent basis, which will increase transparency but in an appropriate manner
- The government is providing the ATO with increased funding to facilitate systems and other agency improvements to deliver on all these initiatives, with many more foreshadowed as the G20/OECD BEPS reports are issued in final form towards the end of 2015, and their international implementation begins during 2016
For global taxpayers with any Australian operations, the phoney war has ended: there are serious legislative provisions on the floor of parliament, which are expected to be passed without opposition, and quickly. The MNAAL comes into effect on 1 January 2016, so there is little time to consider its impact on existing business models, and whether remedial action is appropriate.
Groups which have to report uncertain tax positions, whether for accounting or tax disclosure purposes, have only a very short period of time within which to consider their position.