On 10 August 2009, the Commissioner of Taxation released the 2009-2010 compliance program and outlined the focus areas of the ATO for the coming year. Although the program does deal with all types of taxpayers and organisations and a number of different taxes, this G+T Tax Update will focus on the income tax areas that the Australian Taxation Office will be focussing on with respect to large corporate taxpayers (ie those with a turnover greater than $250 million).
In highlighting the significance of the large business category, the Commissioner of Taxation notes that large business pays 36% of the total income tax collected in any year.
The Commissioner of Taxation states that the greatest risk to income tax collection from large business over the next four years comes from the following four areas:
- cross-border financial arbitrage;
- transfer pricing / profit shifting;
- restructures generating non-taxable gains or deductible losses; and
- inappropriate depreciation claims.
Key risk indicators
Throughout the chapter dealing with large business are references to "indicators" which are more likely to result in increased focus from the Australian Taxation Office. These include:
- inconsistencies between financial and accounting results when compared to the tax paid, and in particular accounting profit to taxable income reconciliations;
- transactions where the income tax consequences of a transaction do not reflect commercial outcomes;
- large complex transactions which appear contrived and without a sound commercial basis;
- information obtained from sharing of tax information with treaty partners;
- the Commissioner's assessment that a taxpayer's corporate governance structures and internal controls dealing with tax are weak; and
- participation in "mass-marketed" schemes.
Increased use of Annual Compliance Arrangements
The Commissioner promotes Annual Compliance Arrangements (ACAs) in order to provide certainty for both the taxpayer and the ATO.
An ACA is essentially an arrangement between a corporate taxpayer and the ATO founded on the company having a sound tax risk management framework and a commitment (given in writing by the company's key officers) to provide full and true disclosure of all relevant and material facts in real time. Once this commitment is given, the ATO would workshop with the company the tax position for major transactions and would seek to jointly assess tax risks of the company. At the end of the income year, the ATO would jointly review the income tax return and statutory accounts, and undertake a book to tax reconciliation of the differences. This appears to be a very resource intensive exercise for both the taxpayer and the ATO.
It is apparent that at the present time, few businesses have taken up the offer to participate in ACAs. Significant effort will be required by the ATO to change this and taxpayers will need to consider what benefits emerge from entry into an ACA given the significant up front time and cost commitment.
Introduction of ATO Lead Relationship Managers
With a view to increasing the ease of doing business with the ATO, the ATO is piloting a new initiative to provide taxpayers with a single contact person to fast track critical issues and help improve a taxpayer's interaction with the ATO. We would hope that the measure will result in obtaining more efficient service from the ATO and without the need to manage multiple relationships across various offices around the country.
The Commissioner of Taxation has identified the unique challenges likely to be encountered in the next year associated with implementation of the Rudd Government's two major tax reform measures announced during the last 12 months namely:
- implementation of the one-off investment allowance; and
- the introduction of capital account treatment for Managed Investment Trusts (MITs).
We would expect that as taxpayers start filling tax returns start for the first year in which the measures apply, that enquiries as to the treatment will commence. For example, these may be on interpretational issues on such questions as "starting to construct" and "use in Australia".
In relation to the capital account treatment for MITs, it will be necessary for affected taxpayers to carefully consider the advantages and disadvantages of making the election. For those taxpayers not making the election to enter the regime, the factual and technical support for their treatment of gains and losses is likely to be heavily scrutinised. In this regard, we refer you to our G+T Tax Update from July 2009 for further information on the capital / revenue account distinction.
Tax sharing with tax treaty partners
The ATO has acknowledged its reliance on information provided by tax treaty partners. Accordingly, taxpayers with headquarters and operations in well tax jurisdictions with which the ATO cooperates (for example the United States Internal Revenue Service and the New Zealand Inland Revenue) need to be aware of the type of information being provided to foreign revenue authorities by their foreign affiliates.
Increased focus on loss utilisation
In light of the significant impact of the global financial crisis (GFC) on the corporate tax base, the ATO has indicated that it will review loss utilisation by large businesses.
This comes as no surprise as successive Australian Governments have been trying to reduce large taxpayers' ability to claim tax losses, through legislative measures such as loss integrity measures, tax consolidation and for a short time, the abolition of Same Business Test for taxpayers with turnover of greater than $100 million.
The Commissioner acknowledges that there may be genuine losses deductible in Australia which are attributable to the GFC and which are deductible in Australia. The Commissioner's sees his role as involving:
- the review of "non-genuine" losses;
- identification of errors and miscalculations;
- review of arrangements which "inappropriately" attribute foreign losses to Australia;
- review of finance related (eg interest) deductions;
- the application of the Continuity of Ownership Test (COT) and Same Business Test (SBT) to losses; and
- reviewing arrangements which inappropriately apply foreign losses against domestic income (for example the introduction of loss-making foreign operations and assets to an Australian corporate group, as well as transfer pricing (see below)).
Accordingly, we would recommend that taxpayers consider and evaluate their loss preservation and utilisation strategies and ensure that they have documentation to support tax deductions claimed with respect to those losses (eg supporting COT and SBT positions).
In considering the utilisation of tax losses, taxpayers should also be mindful of the opportunities emerging from the retrospective changes to the loss recoupment rules. On 4 September 2009, the Assistant Treasurer released exposure draft legislation to amend these rules. The proposed changes aim to improve the operation of the continuity of ownership test where a company has multiple classes of share , modify the definition of voting power, and clarify the operation of the same business test for consolidated groups. Submissions on the measures are sought by 2 October 2009.
Transfer pricing continues to be an area where the Australian Taxation Office maintains its focus. The emerging trends which the Commissioner of Taxation has identified and which will be scrutinised include:
- restructuring Australian based operations to shift assets, functions and risks offshore on a non-arm's length basis (including the transfer of intellectual property);
- the payment of excessive interest, guarantee and other fees;
- provision of free services to overseas affiliates; and
- the allocation of income and expenses in a manner inconsistent with the economic activities conducted in Australia.
The program also hints at a review of the Advance Pricing Arrangements (APA) program with a view to making it more attractive to taxpayers.
The Commissioner of Taxation has correctly identified that companies in industries dramatically impacted by the GFC such as the commodity, property and finance sectors, and which have experienced significant accounting write-downs of core assets, may find that they have breached their thin capitalisation safe harbour calculations.
Taxpayers which have had significant impairment or devaluation of their assets, as well as taxpayers which were approaching their thin capitalisation safe harbour limits in previous years, should consider reforecasting their thin capitalisation position and, if appropriate, take steps to enhance their thin capitalisation balance sheet before year end (eg by reducing debt, increasing equity and restructuring loans with related parties etc).
We also note that a number of taxpayers have relied on the alternate arm's length debt test in order to determine a maximum allowable debt for thin capitalisation purposes. In practice, those taxpayers may have only performed substantive arm's length debt testing in the first year of income that the test was relied upon. However, the Commissioner may also be expecting those taxpayers to be revisiting the initial testing on the basis that the GFC constitutes a material change to the state of the economy (refer paragraph 118 of TR 2003/1).
The ATO has indicated that it will review outcomes achieved on tax consolidation to ensure that those outcomes are consistent with legislative intent.
Taxpayers need to be particularly mindful of proposed legislation as announced by the then Assistant Treasurer Chris Bowen on 28 April 2009, intended to clarify and amend various aspects of the tax consolidation measures (including calculation of the Allocable Cost Amounts). Many of these changes will have retrospective impact which affect previous tax returns and calculations.
For further details on these proposed changes, we refer you to our tax update of May 2009.
Interaction of CGT with other tax law
Some of the Commissioner of Taxation comments suggest that he will review situations where the tax consolidation rules do not correctly interact with the capital gains tax rules. There is also a suggestion that the ATO will review situations where "foreign residents are positioning themselves to circumvent CGT obligations" as well as reviewing "recharacterisation" issues.
Cross border financing arrangements
The Commissioner has indicated that he will review "instances of contrived and artificial arrangements to seek to obtain tax benefits in Australia by exploiting provisions such as sections 25-90, section 23AJ and Division 820". The Commissioner of Taxation appears to be focussing his efforts in reviewing "debt push-down" transactions.
In relation to section 25-90, we note that Draft Taxation Determination TD 2009/D8 was recently released. This determination is welcome news for taxpayers and resolves recent uncertainty regarding the ability to claim a deduction for a cost related to a debt interest under section 25-90 where no section 23AJ dividend is derived in the year in which the cost is incurred. The Commissioner confirms in TD 2009/D8 that it is not necessary for a taxpayer to actually derive a section 23AJ dividend in the same year in which the cost is incurred. However, there must be a sufficiently clear nexus between the relevant cost and either the production of an actual section 23AJ dividend in the year the cost was incurred or an expected section 23AJ dividend in a future income year.
Non-resident withholding tax
The Commissioner of Taxation has indicated that he will focus on situations where payments have been recharacterised to avoid withholding tax eg by the payment for services and management fees, concealment of arrangements, and back-to-back arrangements. Again, we would recommend that taxpayers review their treatment of payments on a regular basis and examine what they are actually paying for. Taxpayers need to be aware of the Commissioner's evolving views on the issue of apportionment of payments, as well as his views on the royalty withholding tax implications associated with the assignment of copyright (refer to Taxation Ruling TR 2008/7).