Changes to the tax system need to be based on a real, not perceived, flaw.
The new buzz words in tax law and policy are "base erosion". There is an implication that this is a major fiscal issue caused by the digital age.
The Assistant Treasurer has been vocal, saying "the international rules that govern taxation have passed their use-by date. Designed for the industrial era, the tax rules have failed to keep pace with the rapid changes in global commerce."
While this sounds plausible, a closer examination of the facts suggests some political hyperbole might be at play.
There is no denying the digitalisation of the world has led to increased profit mobility. But at the same time, there is really nothing new under the sun. The base erosion concept has been around for decades, and a variety of rules have been developed to deal with multinational companies.
These include the controlled foreign corporation (CFC rules), thin capitalisation which deals with interest deductibility, entity classification rules which deal with hybrid entity forms, debt/equity rules which apply a quasi-substantive approach to determining whether outgoings are interest or in reality a profit return and so on. This is not to mention the general anti-avoidance rule (Part IVA) which of course can also apply when none of the specific anti-avoidance rules operate.
There has been a constant process of renewal of the armoury of rules which I have listed above. In fact, most of them are second generation versions of the original legislation which have emerged post 2000. We have only this month had new bills released to update transfer pricing and Part IVA.
Further, the Government is currently working on rewrite of the CFC rules and also specific purpose anti-avoidance rules to be known as the foreign accumulation fund rules, which we expect will be progressed at some stage this year.
I think that we, and most of our clients, would consider the ATO to have the benefit of some powerful legislative tools and a very active compliance program. Of course, under Australian tax law the onus is also on the taxpayer to rebut the assessment made by the ATO. This is not an environment where tax liabilities are easily manipulated.
In the light of this, is there a significant base erosion/profit shifting issue in Australia?
I would need to see some evidence in the Australian context that there has been a substantial undermining of the integrity of the tax system. A special reference group has been formed by the Minister to look at the activities of multinational enterprises, and the outcome of that group's inquiries may be instructive in this regard.
Clearly, there is a global movement to examine the question of base erosion and profit shifting as of course evidenced by the OECD inquiries. Perhaps the US has greater cause for complaint where companies that develop intellectual property and have significant local workforces "offshore" profits by placing intangibles offshore. Australia can't lay claim to be the "rightful" home of too many global household brand names. Our "base" is not being eroded in the same structural sense as is the case in the US. The question more often than not is simply whether we are paying too much to use those assets. Of course, that's still a valid question but is answered by reference to conventional arm's-length transfer pricing rules.
We do have, as I mentioned, new transfer pricing rules and revised general anti-avoidance rules (assuming that in fact that they are enacted). I suspect that coming to grips with these new rules which, in the case of the transfer pricing rules and express reconstruction power, have some quite broad powers is going to keep the taxpayers and their lawyers busy for some time.
To the extent that the tax law may evolve in a more fundamental structural sense, there are a number of potential avenues for this, but the most likely available option is some sort of unilateral extension of current rules which go to the deductibility of payments to offshore related parties. This could occur, for example, by extending thin capitalisation type concepts to deductions generally to impose limits over and above the arm's length pricing currently required under the transfer pricing rules. So, royalty deductions to related parties could be artificially limited in some way in certain circumstances.
I would imagine such rules would be strenuously opposed by taxpayers who would (with some justification) argue that provided payments they make are on arm's length terms then they should be entitled to full tax relief. Again any such rules would need to comply with the treaties that are in force. More importantly, they need to be based on a real, not perceived, flaw in the taxation system.