What has happened?
On 16 September 2015, the Federal Government introduced the Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015. The Bill contains two significant proposals, both of which were signalled in the 2015-16 Federal Budget in May 2015 (see 2015-16 Federal Budget - key tax announcements for business).
The two proposals target multinationals (that is, corporate groups with annual global income of $1 billion or more), and are both proposed to be effective from 1 January 2016.
Introduction of country-by-country reporting
The first proposal is the introduction of country-by-country reporting for transfer pricing purposes. This introduces into Australian law proposals first mooted by the OECD as part of the Base Erosion and Profit Shifting (BEPS) project (for more on the BEPS project see Tracking the Changes to Base Erosion and Profit Shifting).
The Bill provides that country-by-country reporting would apply to a significant global entity. Broadly, this means a multinational group with annual global income (ie group income) for the period at issue of $1 billion or more. This can be determined by the Commissioner based upon his reasonable belief if global financial statements have not been prepared for the period in question, although that determination can be objected to. The provisions also provide that the $1 billion figure is an Australian dollar figure, and that global financial statements must be converted to Australian currency at the average exchange rate applicable for the period in which the statements are prepared. The provisions specify that the exchange rates must be obtained from non-associated parties.
Such groups will be required to provide the ATO with information on revenues, taxes accrued and paid, pricing policies relevant to transfer pricing, activity (transactions, operations, dealings) and the allocation of profits in each country in which they operate.
The explanatory memorandum to the Bill reminds taxpayers that transfer pricing documentation requires a three-tiered approach:
- a master file providing an overview of the global group,
- a local Australian file focusing on activities involving the Australian entity, and
- a country-by-country report.
Where the master file and country-by-country report are provided to an overseas revenue authority, then they will not need to be duplicated in Australia. This is because the ATO can obtain the information through that overseas revenue authority using existing exchange of information arrangements.
Country-by-country reporting is in essence a transparency initiative. The country-by-country reporting proposals will provide the ATO with a greater level of information in which to consider the application of the transfer pricing regime in Australia and in which to select multinational taxpayers for closer scrutiny and investigation.
The proposal also represents a potentially compliance cost intensive process for taxpayers. It seems that the Government is assuming that similar proposals will be adopted in other countries to reduce global compliance costs for taxpayers – that remains to be seen.
What should you do about country-by-country reporting?
There does not seem much doubt that these proposals will pass into law. As a consequence, prior to 1 January 2016, if multinational groups have not done so already, they need to review current policies, and ensure that risk governance and transfer pricing policies applicable in Australia take account of the country-by-country reporting requirements. For example, it will be necessary to ensure there are processes to establish, retain and benchmark supporting documentation and to test whether the annual global income testis satisfied on a year by year basis.
Introduction of the multinational anti-avoidance law
The second proposal in the Bill is the introduction of the multinational anti-avoidance law.
This is a proposed addition to the general anti-avoidance provisions Part IVA of the Income Tax Assessment Act 1936 (Cth). The stated intention of the new proposed provisions is to counter the use by multinationals of artificial or contrived arrangements to avoid the attribution of profits through a taxable presence in Australia.
There are a number of requirements which need to be met before the multinational anti-avoidance law could potentially be applicable:
- again, it only applies to multinational groups that satisfy the significant global entity provisions described above in relation to country-by-country reporting (ie annual global income (group income) for the period at issue of $1 billion or more); and
- it applies where there is a scheme under which a foreign entity in the group supplies goods and/or services (other than equity interests, debt interests or options over equity or debt interests) to unrelated Australian customers; and
- activities must be undertaken in Australia directly in connection with the supply; and
- those Australian activities must be undertaken in whole or in part by an associated Australian entity or an Australian permanent establishment of the foreign entity, or by an unassociated Australian entity that is commercially dependent upon the foreign entity; and
- the foreign entity obtains ordinary income or statutory income from the supply; and
- some or all of that income is not attributable to an Australian permanent establishment of the foreign entity.
It is notable that a number of the above requirements contain terms that are either currently defined in Australian tax law (such asordinary income or statutory income), or are not defined (such as commercially dependent) and will be subject to interpretation by the Commissioner, and eventually, no doubt, the courts. This requires multinational Boards to seek advice and carefully navigate the proposed provisions when assessing risk in Australia.
In addition to the above requirements, the multinational anti-avoidance law will only apply if, taking into account specified factors, it can be concluded that the scheme was entered into for the principal purpose or a principal purpose of enabling a taxpayer to reduce Australian taxes or reduce Australian and foreign taxes (with a deferral of foreign tax being relevant unless there are reasonable commercial grounds for the deferral). The specified factors taken into account include the extent of activities performed in Australia and outside of Australia relating to the supply.
It is notable that the multinational anti-avoidance law applies a principal purpose test as opposed to the dominant purpose test applicable for the remainder of Part IVA. That is a less onerous test that will also be subject to interpretation by the courts. It is also notable that foreign taxes are taken into consideration, but interestingly 'only so far as information relevant to foreign tax is available to the Commissioner' and the Commissioner is not required to make inquiries. This places a burden on a taxpayer to provide evidence to the Commissioner about tax paid under foreign law. It is also notable that the original proposal in the Federal Budget which confined these measures to structures which shift profits to no tax or low tax jurisdictions does not appear in the Bill. The 'comparable tax' regime in a foreign jurisdiction will certainly be a factor when considering the purpose of a particular structure.
If the multinational anti-avoidance law applies, the Commissioner has the standard powers under Part IVA to reconstruct the scheme to counter the tax benefit obtained. The Commissioner will assume that the foreign entity had a permanent establishment in Australia and that some or all of the activities of the foreign entity were undertaken by and attributable to that deemed permanent establishment. Arm's-length profits will be subject to Australian corporate income tax, and administrative penalties of 100% will be applicable, alongside shortfall interest. Depending upon how the reconstruction occurs, there may also be withholding taxes applicable to payments deemed to have been made by the deemed permanent establishment (for example royalty payments or payments of interest to treasury companies within the multinational group). Obviously, there will be future argument before the courts on this aspect of the multinational anti-avoidance law as well. We anticipate it to be the source of controversy and dispute.
What should you do about the multinational anti-avoidance law?
Multinational groups which derive income from Australian sales to unrelated Australian customers but do not bring that income to tax in Australia need to consider their current arrangements. It will be important to seek advice and consider carefully the risk of the multinational anti-avoidance law being applicable. Due to the potential for a significant imposition of tax, the Board needs to be engaged in this process. Risk governance processes also need to be reviewed and updated, particularly to ensure that the rationale or purpose for the multinational structure adopted is available.
The explanatory memorandum provides a number of examples which suggest that structures such as the following structure will NOTbe subject to the multinational anti-avoidance law. Multinational groups need to carefully consider this and the other examples in the explanatory memorandum, and take advice to assess their structure and manage their risk.
Click here to view image.
In addition, it should not be forgotten that if the multinational anti-avoidance law applies, the other provisions in the remainder of Part IVA remain to be considered. This includes considering what the alternative postulate or alternative structure would have been had the scheme in question not been adopted (further detail on those provisions in Part IVA can be found here). These requirements also require contemporaneous evidence of what the alternatives were, and why they were dismissed. Again, risk governance is key.