Taxpayers subject to the new multinational anti-avoidance law should determine whether they restructure or stay firm.
On 16 September 2015, the Government introduced legislation into Parliament to implement the new multinational anti-avoidance law (MAAL). This was announced as part of the 2015-16 Federal Budget and is targeted at multinationals which are considered to be avoiding the attribution and taxation of business profits in Australia. As follows we provide an overview of the MAAL, implications for taxpayers and some observations on how taxpayers may respond.
When will the MAAL apply?
The MAAL applies to "significant global entities" (member of a group with global annual revenue of $1bn or more). The Government has indicated that the MAAL is targeted at 30 large multinationals, although up to 100 companies may need to review their arrangements to make sure they comply with the law.
The MAAL is an extension of the current general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 (Cth). In broad terms, it will apply where:
- a foreign entity derives income from making "supplies" to Australian customers (eg. goods and services, including digital supplies);
- there is an entity in Australia (associated or commercially dependent) which supports the making of those supplies (eg. assisting with advertising, marketing and client relationship);
- the foreign entity avoids the income derived from the supply being attributable to a permanent establishment of that entity in Australia (effectively an avoidance of a taxable presence in Australia); and
- it would be concluded that the above structure was established for the principal purpose or for more than one principal purpose of enabling the foreign entity to obtain a tax benefit (effectively a reduction in their Australian tax liability).
If the MAAL applies, the foreign entity will be taxed as if the income had not been avoided. That is, the foreign entity will be taxed based on a fiction ‒ a reasonable alternative postulate which comprises a reasonable alternative to the existing structure. For example, it may be considered that a reasonable alternative would involve an Australian entity making the supplies directly to the Australian customers and therefore the sales revenue would be booked in Australia rather than overseas.
Implications for taxpayers
A key practical issue is identifying the reasonable alternative postulate ‒what would a reasonable alternative Australian taxable presence look like and how much income would be attributed to this? This is particularly important as it will form the basis for any tax adjustment (ie. increase in Australian tax liability) and also may give rise to a risk of double taxation where the tax authority in the other jurisdiction does not agree.
Having regard to Australian case law on Part IVA the answer often requires a rather involved “what if” analysis. As Part IVA is an integrity regime it is based on a comparison of what would have happened – a counterfactual. In many cases there will not be a clear cut answer, with a fairly broad and deep spectrum of possibilities and scope for disagreement between taxpayers and the Commissioner of Taxation. Some of the questions that may be relevant to think about in examining the new provisions are:
- if most (all?) companies in the same industry structure their dealings with Australian customers in the same way ‒ does this reflect the "industry standard"?
- how do you re-define the industry standard and what should be occurring?
- how do you take into account the group’s circumstances? Do you assume a structure similar to structures in other countries?
- how do you best determine how much income should be attributed to the Australian presence?
- how do you determine the margin or profit that is attributable to the Australian presence? In high turnover businesses, even a difference in margin of 1% can be significant ($ millions). Also, how do you determine a formula that is flexible enough to deal with future developments in the business (eg. digital disruption)?
A further issue is the lower "tax motive" threshold. The existing provisions in Part IVA target arrangements which are "predominantly" tax driven. In contrast, the MAAL is intentionally broader in scope and may apply where avoiding Australian tax is only "one of the purposes" behind a structure (and also applies where one of the principle purposes is avoiding foreign taxes). For example, the MAAL may cancel out a reduced Australian tax liability that is essentially a "collateral" benefit of a structure that has been adopted by a multinational for foreign tax reasons. In addition, the Government has doubled the penalties which may apply to structures caught by the MAAL. Taxpayers may now potentially face penalties of 100% of the tax shortfall, as well as interest.
The UK has introduced similar legislation, in the form of the Diverted Profits Tax (colloquially referred to as the "Google tax"). The aim of the UK tax was to encourage taxpayers to restructure their arrangements so that the tax did not (potentially) apply to them. With respect to the MAAL, given the uncertainty around when and how the tax may apply, some taxpayers may choose to do the same. Others may choose to stay firm and deal with any questions from the Commissioner as and when they arise.
Observations for those who stay firm
It goes without saying that those taxpayers who are confident that their arrangements are consistent with the MAAL should have robust supporting documentation to substantiate their position. However, importantly, they will need to ensure that what actually happens is consistent with that documentation. In our experience, the Commissioner will test the facts and assumptions in supporting documentation and representations by taxpayers. He may interview people and request information which relates to the domestic and global operations. Slide decks and walk-throughs may not be enough to address the Commissioner's information requests, and there is a real risk of a more detailed review being conducted.
Example 3.9 in the Explanatory Memorandum to the new legislation foreshadows that the Commissioner may challenge arrangements where what actually happens is not permitted under internal agreements. In practice, arm's-length parties sometimes depart from the terms of a written contract where this is convenient and/or considered commercially favourable or necessary. Departure from internal agreements, processes and controls likewise may occur within a wholly owned group for a number of reasons. The extent to which this has occurred and how it impacts on the tax position should be tested.
A key challenge for taxpayers who stay firm will be how they communicate to the Commissioner that there is no reasonable alternative postulate under which their taxable presence in Australia would be greater (and/or that under the alternative the same tax liability would arise). This may not be easy and reliance on global policies, foreign tax implications and commercial drivers alone will not be sufficient. Taxpayers should be ready to explain and support the commercial rationale for the adopted structure, be able to demonstrate that the form and substance of the arrangements are consistent and be in a position to explain why an alternative arrangement would not be "reasonable" in the circumstances.
Observations for those who choose to restructure
Those taxpayers who choose to restructure may benefit from frank and open dialogue with the Commissioner on the proposed restructure so that it addresses and pre-empts any concerns which may arise in the future. These discussions should also take into account the potential tax consequences of the restructure, such as the transfer of functions, assets and risks to or between Australian entities. These discussions may be in a form and context which does not prejudice the parties' rights in relation to other issues.
Based on our experience, we expect that disagreements are likely to arise at the practical level noted above ‒ as to what the new structure should look like and, in particular, what profits should be "attributed/allocated" to the Australian taxable presence. Taxpayers will need to be able to clearly articulate the commercial drivers behind their proposed structure. In this regard, input from internal stakeholders (business/operations) should be considered essential. Likewise, input may be sought from overseas tax authorities, to address any risk of potential double taxation.
If passed by Parliament as expected, the MAAL will apply from 1 January 2016. It will apply to all arrangements (ie. not just those entered into after this date) and could apply to arrangements which have been in place for 5, 10 or even 20 years.
Taxpayers subject to the MAAL should determine whether they restructure or stay firm. Those who stay firm should test and support their tax position. In either case, taxpayers may benefit from early, frank and open dialogue with the Commissioner, which may be assisted by an engagement framework.