In effect, a parallel, but more draconian, tax compliance system is being created for foreign investors.
The Australian Government has introduced significant changes to Australia's foreign investment review system designed to ensure that foreign investors comply with Australian tax laws, including requirements that foreign investors must provide to the Australian Taxation Office (ATO) information relating to the investment, and notify the ATO of any transactions to which Australia's transfer pricing or anti-avoidance tax rules may potentially apply.
These changes will be imposed through standard conditions included in all foreign investment approvals under Australia's foreign investment regulatory regime. Additional conditions may also be imposed where the ATO considers there is a significant tax risk with particular foreign investments.
What are the changes?
The Australian Government has announced that, as part of our foreign investment review process, a range of standard conditions and some additional conditions may be imposed on foreign investment in Australia. The standard conditions that are likely to be imposed are requirements on foreign investors (and their associates) to:
- comply with Australia's taxation laws, including paying any outstanding tax;
- provide any documents and information requested by the ATO in connection with the application of Australia's taxation laws;
- notify the ATO of any transactions to which Australia's transfer pricing or anti-avoidance tax rules may potentially apply; and
- provide an annual report to the Foreign Investment Review Board (FIRB) on compliance with the tax conditions.
Depending on the circumstances of the foreign investor and the investment being made, additional conditions might be imposed where a significant tax risk is identified. Those conditions may include a requirement that the foreign person:
- engage in good faith with the ATO to resolve any tax issues; or
- provide information to the ATO on a periodic basis, including giving details of minimum forecast tax payable.
Why are these changes being made and what do they mean to you?
These tax conditions represent a much closer formal alignment of the national interest assessment criteria under Australia's foreign investment regulatory regime and the tax laws. Over recent years, tax has become an increasingly important consideration in FIRB's assessment of foreign investment applications under Australia's "national interest" test.
The importance of tax in FIRB deliberations was boosted by the appointment of the former Commissioner of Taxation, Mike D'Ascenzo, as a member of the FIRB in 2013. Subsequently, the ATO has assumed responsibility for administering a number of aspects of Australia's foreign investment regime, including aspects of residential land acquisitions and the agricultural land register.
The new tax conditions are being introduced against a background of considerable political pressure; declining commodity prices have resulted in a significant reduction in Australia's tax revenues, and there is a perception that foreign investors are not paying their fair share of tax in Australia. So the Government is under pressure to be seen to be tough on multinational tax avoidance.
These new tax conditions being introduced under Australia's foreign investment regime are very significant. The key significance of incorporating these conditions lies in the consequences of non-compliance. In effect, a parallel, but more draconian, tax compliance system is created for foreign investors. Under Australian income tax laws an alleged breach of the tax law is subject to the imposition of penalty tax and interest, which is generally imposed at a level commensurate with the breach. The taxpayer has well defined rights of objection and ultimately may appeal the issue through the court system. The ATO has powers which are relatively clear and there is a well-defined path for dispute resolution.
In contrast, where a foreign investment is subject to these new FIRB conditions, the foreign investor may not have the benefit of the safeguards offered to other taxpayers. There is a lack of a well-defined resolution process. In particular, under the new foreign investment tax conditions:
- The ATO is granted very broad and unrestrained powers to require the production of information and documents in relation to the acquisition or ongoing conduct of operations. The ATO also has very wide powers under the tax laws. There is some uncertainty around the offshore reach of the ATO's access powers existing tax laws. However, the FIRB conditions unambiguously require access be granted to the ATO to offshore documents and information and extending to information held by "associates" including any outside of Australia. Foreign investors should be able to claim privilege over documents subject to legal professional privilege ‒ given that the right to claim privilege has not been expressly abrogated.
- For cases where a "significant tax risk" is identified (that concept is not further defined but will presumably be determined by the ATO) the foreign investor may be required to engage with the ATO to obtain advance tax rulings. The foreign investor may also be required to provide the ATO with an estimate of minimum tax payable on a periodic basis and explain any variances where the actual tax paid differs from the estimate.
The meaning of the term "associate" is taken from the tax law and is extremely broad. It means that foreign investors will have to closely consider whether the actions of joint venture partners or other investors with whom they may be collaborating in connection with the investment could lead to a breach of the foreign person's own FIRB tax conditions.
Any breach of these conditions in whole or in part may lead to significant adverse consequences for the foreign investor, including
- prosecution, possibly resulting in up to 3 years' imprisonment;
- civil penalty orders (fines); and
- an order for compulsory asset divestment (if a civil penalty order has first been obtained).
These sanctions ‒ and in particular the largely unfettered power of the Treasurer to order divestment in cases of breach ‒ is why this "parallel tax system" is significant for foreign investors.
There is no necessary relationship under the FIRB rules between the scale of any alleged breach of condition and the sanction which is imposed. So, for example, transfer pricing is a notoriously subjective area which can lead to significant differences between the ATO and taxpayers ‒ and with each party being supported by experts who have different views of the same transaction. If the ATO forms the view that the transfer pricing rules may have been breached ‒ but there was no notification by the foreign investor ‒ then there may be a question as to whether such notification breach would be sufficient to result in a divestment order. There currently is no guidance on this. The foreign investor may have taken advice and believed they were acting in full compliance with the law.
No doubt the regulator will act with good intention. However, tax is notoriously an area where reasonable minds may and often do differ. There is certainly no bright line test under the new conditions, particularly on the issue of materiality. Clarity around these new conditions and how they will be interpreted and enforced and how disputes may be resolved will be critical, when the consequences of non-compliance are so dramatic.
The new rules will require foreign investors to consider tax issues in a more formal way than previously and before submitting any application to FIRB under Australia's foreign investment screening processes. In some cases it will inevitably significantly extend the approval process timing.
Although the rules only apply prospectively, foreign investors with existing Australian holdings need to exercise extreme care that any reorganisation does not trigger the requirement to obtain FIRB approval ‒ and thus result in the application of the new tax conditions regime.