The Australian Labor Party (ALP) has outlined proposed measures to combat multinational tax avoidance in a 2 March 2015 policy launch. The proposed measures expect to raise $1.9bn over three years, and comprise:
- impose a ‘worldwide gearing ratio’ to limit Australian interest deductibility
- adopt anti-hybrid mismatch rules
- early adoption of the automatic exchange of information standard
- increased funding for the ATO
The measures are forecast to commence in the 2015-16 fiscal year and will be overseen by a panel of experts.
With the possibility of a change in Federal Government in just 18 months’ time, businesses need to give these proposals due consideration.
Measures in detail
On 2 March 2015, the Australian Federal Opposition, the left-leaning ALP, launched a tax policy entitled 'Stopping Multinational Tax Avoidance', with a centrepiece proposal to immediately change Australia’s recently tightened thin capitalisation (thin cap) rules, and restrict interest deductions allowed in Australia to no more than the MNC group’s global debt-to-equity ratio. A similar proposal is currently the subject of consultation as part of the G20/OECD BEPS project, and the ALP’s proposal would see Australia acting unilaterally, and outside the global response advocated by the G20.
It’s just an opposition policy...
Opposition statements often fail to attract interest, particularly in out-of-cycle years; but this may well be an exception which does demand consideration.
Australia’s next federal election must be held between August 2016 and January 2017; take a guess and choose November 2016, which is just 19 months away. Based on recent voter polling, there appears at the moment to be a very real chance of the ALP being voted into power at that election, following which the policy measures outlined in this launch could be expected to be implemented.
The proposed policy measures
Four substantive measures are proposed, which have been costed by the independent parliamentary budget office (PBO) to raise a $1.9bn over the three fiscal years 1 July 2015 to 30 June 2018 (see table below). The measures are as follows:
(i) thin cap changes – worldwide gearing ratio
Currently, Australia’s thin cap rules are based on a debt-to-equity ratio of 1.5:1, having been brought down from 3:1 with effect from 1 July 2014. The current regime provides three means of calculating the permissible level of debt: the ‘safe harbour’ method (1.5:1), the arm’s length method (reportedly very rarely, if ever used) and a worldwide gearing ratio. But this version of the worldwide gearing ratio operates as a savings measure, not as a more restrictive cap.
Under the ALP proposal, the worldwide gearing ratio will be the only permissible method, with the other two methods proscribed. Apart from likely reducing the amount of deductible Australian interest expense, this change will increase compliance costs and importantly will neutralise a funding advantage currently provided to Australian-based outbound MNCs.
There is no mention of how double taxation would be avoided; presumably interest deductions disallowed under the proposal will not be relieved in Australia to any extent, as is currently the case.
Readers will be aware this is a measure currently under consideration through the G20/OECD BEPS project, specifically, Action 4. Through the public comments and the public consultation on Action 4, many practical concerns have been raised about the proposal, and it remains to be seen what will be the OECD’s final recommendation on the matter.
The ALP proposal appears to require unilateral action by Australia, ahead of the planned global response through the G20. Whilst the legislative drafting to implement the measure will be straight forward and simple to achieve, the effect on in-bound investment to Australia should require careful analysis before breaking away from the shelter of a global response.
What to watch for?
Existing financial arrangements may need to be reviewed and alternative scenario planning may be appropriate. There was no indication in the released material whether transition provisions will be available. The possibility of the further reduction in deductible interest expense should be considered for all projects underway or in prospect.
(ii) measures to neutralise hybrid mismatches
The effects of hybrid entities and hybrid instruments can be to create 'stateless income', i.e. income which is not taxed in any country. This phenomenon is also described as 'double non taxation'.
Where the domestic laws of individual countries treat entities or financial instruments differently, it is possible to avoid paying tax anywhere. For instance, a security which is treated as debt in the paying country would give rise to a tax deductible interest payment. But if the same security was treated as equity in the receiving state, the income stream would often be relieved of tax in that country. In summary, deductible in one country and not taxed in the other = stateless income.
The BEPS Action 2 report of 2014 made detailed recommendations for the introduction of a globally matched framework of rules to overcome double non taxation. But the nature of the problem requires a global response, in line with the G20 recommendations. It is true that the global response will require domestic legislation to achieve the objective, but unilateral action by Australia will achieve little or nothing, as business will react dynamically to changes in one country only. Global adoption of complementary rules are required to properly address the issue.
The policy material is silent on the changes that will be required to Australia’s current debt/equity rules (Division 974). Australia has adopted a framework to characterise securities as either equity or debt, based on economic substance, rather than legal form. Whilst this is a sensible (and one may even say enlightened) approach, it has inadvertently left Australia out-of-step with many other countries, which still use legal form as the basis for distinguishing between debt and equity interests.
Any legislative move by Australia to attack hybrid mismatches will inevitably involve changes to Division 974, and given the centrality of those rules to the entire financial structure of Australian commerce, it is a matter which will require great sensitivity, consultation, transparency and deep consideration, against the risk of generating very significant disruption and 'unintended consequences' to Australia’s financial system. And all this at the same time as likely Murray reform changes are being addressed.
(iii) Increase in ATO resources
The policy proposes to increase the resources made available to the ATO to pursue multinational profit shifting. The rationale for this initiative is that 'evidence' exists that 'additional compliance from the ATO is yielding greater revenue from multinationals'.
(iv) third party data matching – early start date
This proposal does not refer to the new global standard for the exchange of financial information – the automatic exchange of information (AoEI), adopted by the OECD and the G20 during 2014 – but rather to an acceleration of tax data exchange under Australia’s various bilateral tax treaties, and other existing information exchange protocols.
With a proposed start date of 1 July 2015, this initiative will be several years ahead of the AoEI implementation date, as currently proposed by the government (the AoEI will apply to new accounts opened after 1 January 2017, and to pre January 2017 accounts of significant value, with information to be exchanged from September 2018).
The information will be exchanged at the level of national revenue authorities (for Australia – through the ATO), although it is not clear whether financial institutions will be required to implement new systems, or whether it will be a case of exchanging the information which is currently captured and available. With the proposed start date just 3 months away, it would seem unlikely banks will be able to do any more than provide information currently held within their systems.
(v) expert panel
It is said the policy has been developed with input from 'some of the country’s best accounts, tax lawyers and policy thinkers', following a round table process held in November 2014.
Going forward, and once in government, a new panel of experts will be formed to provide guidance and direction to the implementation of the new rules.
The figures released with the policy, and costed by the PBO, are as follows:
|3rd Party Data Matching – early start||-||60||20||10||90|
|Increased ATO Compliance||-||-32||9||90||67|
|Bifurcation and Hybrid Mismatch||-||-||50||50||100|
|Worldwide Gearing Ratio||-||600||500||550||1,650|
Whilst the timing of the implementation of these measures is clearly unachievable – the ALP would not be in a position to legislate any of these measures until early in calendar 2017 at the earliest – it seems the figures are about pure party politics. The ALP has been under pressure from the government to advance its own ideas for tackling Australia’s budget deficit problem, and this has been the first move – for a total of less than $2bn.
Whilst it is easy to dismiss this policy as just an opposition gimmick – and the lack of announced details supports that view – the proposals cannot be ignored by business, and the policies collectively provide another negative for Australian in-bound investments to negotiate.