What has happened?
On 2 October 2014 the Senate referred an inquiry into corporate tax avoidance to the Senate Economics References Committee for inquiry and report. The Committee conducted public hearings1 in Sydney, Melbourne and Canberra and received submissions from a number of senior executives from high profile multinational corporations and agencies. The terms of reference were to inquire into Tax avoidance and aggressive minimisation by corporations registered in Australia and multinational corporations operating in Australia, with specific reference to:
- the adequacy of Australia’s current laws;
- any need for greater transparency to deter tax avoidance and provide assurance that all companies are complying fully with Australia’s tax laws;
- the broader economic impacts of this behaviour, beyond the direct effect on government revenue;
- the opportunities to collaborate internationally and/or act unilaterally to address the problem;
- the performance and capability of the Australian Taxation Office (ATO) to investigate and launch litigation, in the wake of drastic budget cuts to staffing numbers;
- the role and performance of the Australian Securities and Investments Commission in working with corporations and supporting the ATO to protect public revenue;
- any relevant recommendations or issues arising from the Government’s White Paper process on the ‘Reform of Australia’s Tax System’; and
- any other related matters.
The Senate granted a number of extensions to the committee – but their final report is now due by 30 November 2015. The Senate Committee's interim report has been issued (see here), and contains both an interim view from the majority of the Committee and a dissenting report from government Senators. The key recommendations are discussed below.
Board management of tax risks has always been (in part) directed at managing reputational risks. The inquiry and the related media surrounding the inquiry have demonstrated why Boards needs to strategically manage tax risks. This includes ensuring the Board has independent advice in relation to tax matters. The Committee recommendations also flag the importance of corporate boards' managing tax disclosures and ensuring their tax message is understood by key stakeholders. Although the Senate Committee recommendations relate to income taxes, disclosures and transparency around taxes generally needs to be considered and managed.
The report identifies base erosion and profit shifting (BEPS) as a major risk to Australia's tax base, and in particular, the use of:
- transfer pricing – particularly considering whether arrangements entered into by Australian entities with non-Australian resident associated parties are being entered into at arm's length;
- debt funding and complex financing arrangements generating Australian tax deductions – particularly whether the thin capitalisation rules which are designed to limit excessive gearing in Australia are applying appropriately to multinational groups;
- international business restructures – for example creating marketing, procurement or intellectual property hubs in low or no tax jurisdictions and whether this has inappropriately reduced the tax base; and
- digital business arrangements – for example whether business structures have been established to avoid having an Australian taxable presence, or permanent establishment
as the primary methods used by multinational corporations to lower their worldwide tax burden. A summary of the interim report's recommendations can be found here
Overarching recommendations: Greater tax disclosure and transparency
The overarching theme to the recommendations in the Committee's interim report was the need for reporting of tax paid as compared with income derived from Australia, and greater transparency into the structures and financial mechanisms used by multinationals to structure their affairs. 13 of the 17 recommendations (made in the interim report call for more information disclosures, e.g. country by country reporting, and for the disclosure of excerpts of this information to government agencies (including ASIC and the ATO), Parliament and the public. The cover to the report states 'You cannot tax what you cannot see'.
The majority of the Committee clearly considered information disclosure to the public by multinationals and tax transparency is the key unilateral action Australia can take to combat profit shifting, remove disadvantageous tax competition and to address concerns about an Australian taxable presence. There is obviously some disagreement on the Committee – for example, last week the government introduced a bill to exempt private companies deriving more than $100m of income from the existing tax transparency laws (see here), while the majority of the Committee recommended in the interim report (recommendation 4) that private companies remain in that regime, and that further transparency measures are enacted.
Two of the most interesting transparency recommendations are recommendation 5 and recommendation 11 which involve increasing transparency in relation to tax disputes, including transparency about the settlement of tax disputes by way of a public register of settlements where they are over a certain threshold. In our view, the potential for external focus on settlements of transfer pricing and other disputes in the future would result in more protracted settlement negotiations and potentially fewer settlements. We think this would be contrary to good administrative practice and to the concept of a without prejudice settlement.
Specific recommendations: Transfer pricing
In relation to transfer pricing, the Committee was concerned with the use of the transactional net margin method (TNMM) to set prices and to negotiate advanced pricing agreements (APAs) with competent authorities. As an example, the Committee cited an APA negotiated by Apple with the ATO based on a 4% EBIT/sales ratio, which produced a very low tax rate.
The Committee's report suggests that country by country reporting may enable authorities to produce a better revenue result by using a profit split method.
However we query whether country by country reporting will enable authorities to identify 'channel profits' which is essential to a profit split method being employed.
The Committee's focus on transfer pricing is consistent with the ATO's recent In Focus publications highlighting its concerns about Australian multinational enterprises with marketing hubs offshore (see here) and Australian multinational enterprises with procurement hubs offshore (see here). The ATO publications further highlight to the Boards of Australian multinational enterprises that there is a need to risk review their arrangements for transfer pricing purposes.
Specific recommendations: increased funding to the ATO
The report notes the proposed changes to Part IVA of the Income Tax Assessment Act 1936 (Cth), which will be applicable to multinational corporations with revenue of $1 billion or more which shift profits to a no or low tax jurisdiction in some circumstances. This has apparently been designed to catch 30 identified companies, but there is a suggestion that greater work could be done by the ATO.
The Committee was also concerned about a potential reduction in the capability and performance of the ATO to deal with corporate tax avoidance following on from recent budget cuts and ATO redundancies. Recommendations 10 and 11 of the report call for an independent audit of ATO resourcing, funding and staffing and for the ATO to report to Parliament annually on the number of audits, settlements, legal proceedings and the staff resources used in multinational company tax compliance activities.
The dissenting report
The government Senators' dissenting report expressed concern about the Committee's recommendations given the steps taken by the government to combat corporate tax avoidance by introducing new Multinational Anti-Avoidance laws (these laws are further described in our Alert 2015-16-Budget - Key tax announcements for business), Australia's role as G20 President during 2014, and the release of draft legislation on 6 August 2015 to implement the OECD's country by country reporting regime.
The government Senators also expressed the view that a voluntary disclosure code should apply to the publication of the tax affairs of closely held private companies because this strikes a better balance between the need for transparency and the privacy and competitiveness concerns of business. A change in government may see a change in this balance.
The final report of the Senate Committee is expected to be handed down on 30 November 2015. We anticipate that the final report will continue to recommend a wide range of transparency measures.
Our observations – the challenge for Boards of multinationals
Company Board's should consider their corporate risk governance around taxes and the related tax disclosures – not just income taxes. An independent or second opinion is sometimes warranted. The prospect of an ATO risk review also seems higher in the current tax and economic climate. This is especially the case in the areas of
- transfer pricing;
- excessive debt loading;
- avoiding the establishment of permanent establishments in Australia; and
- the use of tax havens;
The Senate Committee's interim report is not, in and of itself, likely to lead to any changes in Australian tax law. However, some of the themes raised in the report are common and widely recognised as areas for reform, whether domestically or internationally. These include:
- the OECD's BEPS project (for more on the OECD's BEPS project see Minter Ellison overview and Minter Ellison commentary) – outcomes expected at the end of 2015, and in early 2016;
- new tax transparency reporting measures in Australia for some companies – with the first report from the ATO due at the end of 2015 (for further details see here);
- Australia's introduction of country-by-country reporting measures;
- Australia's commitment to enact OECD BEPS measures such as anti-hybrid rules;
- International developments enacting tax transparency measures – including as part of the OECD's BEPS project, and more generally (eg in the European Union);
- the ATO's recent audit activity – especially in transfer pricing; and
- the ATO's recent In Focus publications focusing on multinationals with marketing and procurement hubs
Certainly, the issues considered by the Senate Committee are likely to form part of the political platform (before the 2016 election) for each major party during the election campaign.
There is an immediate need for Boards to risk review the structure of their business operations to ensure that robust tax risk governance procedures (including reviewing supporting documentation) are established and working appropriately. It is likely that the ATO will conduct an investigation of your operations if it is not currently doing so. Boards should anticipate they will need to address the additional evidence made available to the ATO as a part of a future investigation, including expert evidence. This means that being proactive before an ATO investigation commences is sensible risk management.
When conducting a risk review, it is advisable for the Board to seek independent advice, outside of your usual tax adviser. Minter Ellison's expert team is uniquely placed to assist to provide that objective review, as we have represented both the ATO and taxpayers, including on issues such as transfer pricing, including in the recent Chevron case.