Local developmentsi Justified trust and legal professional privilege
The Australian Taxation Office (ATO) continues to apply the OECD concept of 'justified trust' in its assurance approach. Under justified trust, the ATO seeks objective evidence from taxpayers that would lead a reasonable person to conclude that the taxpayer has paid the right amount of tax and met their tax obligations in a timely and transparent manner.
The ATO is continuing to roll out assurance reviews to its top 100 and top 1,000 clients, with specialist tax performance teams assigned to each taxpayer for intensive, tailored assurance reviews. This approach has been coupled with the ATO targeting blanket unwarranted legal professional privilege claims being made over documents that do not contain independent legal advice or that contain aggressive tax planning arrangements disguised as privileged documents, creating an environment with heightened tax risks for investors and large corporates.ii Entity selection and business operations
Income taxes2 are imposed by the federal government and collected by the ATO, led by the Commissioner of Taxation (the Commissioner).3 No state or territory government imposes income tax; however, they each impose their own taxes, including stamp duty, land tax, motor vehicle transfer duty and payroll tax.4
Income tax operates on residency and source bases. Residents of Australia are generally taxed on worldwide income. Non-residents are taxed on Australian-source income.
Australia operates a self-assessment income tax system. Companies are generally subject to a 'full' self-assessment system requiring companies to self-assess their tax liability and report this information to the ATO by lodging their taxation returns.5
Indirect federal taxes, such as the broad-based value added tax called the goods and services tax (GST), which is imposed at 10 per cent, are also self-assessed.
Returns may be audited by the ATO and amended generally within four years of assessment. An unlimited period of review applies in cases of 'fraud or evasion' by the taxpayer.6
Businesses are required to register for pay-as-you-go (PAYG), a single integrated system for withholding amounts from certain types of payments, including:
- business and investment income;
- wages and salaries paid to employees;7 and
- payments to other businesses that do not quote their Australian Business Number.
A reporting framework called 'single touch payroll' applies to all employers and operates by electronically transmitting payroll information in real time to the ATO when wages, salaries and other amounts are paid to employees.
A compulsory superannuation system operates in Australia. Generally, where an employee earns A$450 or more pre-tax income in a calendar month, employers are required to pay 10 per cent8 of an employee's ordinary time earnings9 to a complying superannuation fund of the employee's choice. Complex rules and concessions apply to superannuation contributions and income derived by funds.
Tax concessions are available to not-for-profit organisations, including an income tax exemption. These generally require satisfaction of purposive criteria and registration with relevant authorities.10Entity forms
Australian businesses are commonly structured as companies, partnerships or trusts. All entities must register with the ATO11 and lodge annual income tax returns.
No 'check-the-box' election is available; however, entity selection remains a choice for business owners, with taxation treatment generally following the nature of the entity.Partnerships and trusts
Partnerships (other than limited partnerships (LPs)) are fiscally transparent, with partners being subject to tax on their allocation of income in accordance with a partnership agreement.
Trusts are generally fiscally transparent.12 Beneficiaries that are 'presently entitled' to trust income are usually subject to tax on their share of the trust's taxable income.13 Trusts should distribute their income to beneficiaries annually as trustees failing to do so will be assessed on accumulated income.14
Managed investment trusts (MIT) are an important vehicle type for projects in the property industry, particularly where foreign investors are involved. They are highly suited to passive, long-term investments in Australian real estate for the purpose of deriving rental income streams but are unsuitable vehicles for constructing property for the purposes of sale. The key advantage of a MIT structure is that eligible foreign investors (who are tax residents in certain countries, including Singapore, China, Hong Kong, the UK, the US, New Zealand, Canada, France, Germany, South Africa and the Cayman Islands) can benefit from a 15 per cent final tax rate on trust distributions if certain criteria are met.15 A 10 per cent final tax rate applies for 'clean building MITs'.Companies
Companies are not fiscally transparent and pay corporate tax.
An imputation system applies to distributions16 paid by Australian-resident companies. Under this system, refundable tax credits are available17 to Australian-resident shareholders for underlying Australian corporate tax paid on any 'franked' distribution received. This is intended to alleviate double taxation, which occurs under a classical dividend system.18 Shareholders are taxed on 'unfranked' dividends at their marginal tax rate.
For the managed funds sector, a new corporate collective investment vehicle (CCIV) regime will commence on 1 July 2022.19 A CCIV will be a new form of company used for collective investment, which will be fiscally transparent by default and must have at least one sub-fund. Sub-funds will not have separate legal personality but each sub-fund's assets and liabilities will be segregated from the assets and liabilities of other sub-funds. The CCIV regime is intended to be similar to other countries' managed funds regimes to provide a sense of familiarity to foreign investors.Foreign hybrids
Australia's foreign hybrid rules20 operate to treat foreign companies and foreign LPs controlled by Australians as partnerships for Australian income tax purposes. This impacts the nature of distributions received by Australian members in the foreign hybrid entity.21Choice of entity
Entity choice is generally linked with the character of the investors and the underlying assets. The default vehicle for trading businesses is a company, as it can retain cash without penalty and pay franked distributions.
Outbound investments from Australia are typically structured through companies as they have access to participation exemptions for non-portfolio dividend income22 and capital gains on disposal of shares in foreign companies carrying on active foreign businesses.23
Unit trusts are routinely used in the property sector as they have the advantage of being able to pay 'tax deferred' distributions24 to members and widely held property trusts can qualify as MITs (discussed above).25
Discretionary trusts are generally used in private groups to assist in income splitting between family members.26Foreign Investment Review Board
As part of investing into Australia, a screening process will need to be undertaken with the Foreign Investment Review Board (FIRB). The FIRB is the government agency responsible for examining proposals by foreign investors to acquire interests in Australian real estate (including agricultural land and water entitlements). The FIRB makes a recommendation to the Australian Treasurer on whether to approve foreign investment and any conditions attached to the approval.
The ATO coordinates with government agencies, including the FIRB, to obtain advance warning of significant transactions that might impact revenues.
The FIRB consults the ATO in the approval process to determine the potential tax impact of proposed foreign investment. The ATO provides a risk rating for the proposed transaction and may advise the FIRB to impose tax conditions.27 This process gives the ATO considerable leverage to obtain information at the time of implementation.
A breach of tax conditions may lead to prosecution or a divestment order. The FIRB may also impose other obligations on the investor, such as supplying certain information or requiring an ATO ruling to be obtained.Domestic income tax
Australian-resident companies are taxed on worldwide income at the flat rate of 30 per cent; however, those qualifying as 'base rate entities' are eligible for a reduced rate of 25 per cent from 1 July 2021.28 Companies do not benefit from the 'tax free threshold' for Australian-resident individuals.29
Foreign companies are taxed on Australian-source income at a flat rate of 30 per cent.
Subject to integrity rules,30 individuals are entitled to a 50 per cent discount on capital gains made on assets held for at least 12 months, including where the gain flows through a trust.31 Companies and non-residents are not entitled to this discount.International tax
Offshore profits may be repatriated to an Australian company by payment of exempt non-portfolio dividends; however, subsequent dividends paid by the Australian company will be subject to tax at marginal rates in Australia, unless franking credits are otherwise available. This effectively means that these participation exemptions merely defer Australian tax for Australian-resident shareholders in respect of interests in foreign companies.
Non-residents who receive an unfranked dividend sourced from offshore exempt dividends do not pay any Australian dividend withholding tax (WHT) under the conduit foreign income regime.34 This is intended to promote Australia as a holding company jurisdiction, although the success of this policy is unclear.
Australian branches of foreign subsidiaries are generally subject to tax at the corporate rate on income connected with the permanent establishment (PE).35 These profits can then be repatriated offshore free of further Australian tax.Integrity rules
Taxation of foreign income has been an area of significant legislative change, including new integrity rules targeting profit shifting and avoidance within multinational groups or significant global entities (SGEs).36
SGEs are subject to additional reporting; integrity measures, including the diverted profits tax (DPT) and the multinational anti-avoidance law (MAAL); and increased penalties.
An SGE is an entity that is:
- a global parent entity37 (GPE) with annual global income of A$1 billion or more;38
- a member of a group of entities consolidated for accounting purposes in which another group member is a GPE with annual global income of A$1 billion or more; or
- a member of a notional listed company group and one of the other group members is a GPE with an annual global income of A$1 billion or more.39
For these purposes, a notional listed company group is a group of entities that would be required to be consolidated as a single group for accounting purposes assuming a member of that group were a listed company (and ignoring any exceptions in accounting principles that permit an entity not to consolidate).40 As a consequence, an SGE can include entities such as high wealth individuals, partnerships, trusts, entities considered to be non-material to a group and certain investment entities (and those that they control), including in circumstances where consolidated financial statements have not been prepared.
From 1 July 2017, the aim of the DPT is to ensure that SGEs pay tax that reflects the economic substance of their activities in Australia.
The DPT applies only to SGEs41 earning more than A$25 million revenue in Australia and requires that the SGE, or a foreign entity associate, entered into or carried out a scheme for which a principal purpose was to obtain an Australian or foreign tax benefit.
If applied, the DPT will result in a 40 per cent penalty rate of tax being levied on the affected entity, which must be paid up front. The DPT is intended to minimise the information asymmetry present in transfer pricing cases by shifting the onus to taxpayers to provide transfer pricing analysis before the ATO pursues litigation.
The MAAL was Australia's unilateral legislative response to PE avoidance schemes. The MAAL applies to a scheme if under, or in connection with, the scheme:
- a foreign SGE supplies goods or services to an Australian customer;
- an Australian associate or commercially dependent entity undertakes activities directly in connection with the supply;
- some or all of the income derived by the foreign entity is not attributable to an Australian PE; and
- a principal purpose of the scheme is to obtain an Australian tax benefit or foreign tax benefit.42
Where the Commissioner determines that the MAAL applies, any tax benefits arising under the scheme can be cancelled and penalties imposed.43
The MAAL has largely achieved its intended effect of onshoring profits from sales to Australian customers. In December 2019, the ATO announced that, with the assistance of the MAAL, Google settled its tax dispute with the ATO by paying an extra A$481.5 million on top of its previous tax payment.44 In addition, the operation of the MAAL resulted in A$8 billion in taxable sales being returned to Australia in 2018–2019.45Activities and tax concessions
Australia does not have income tax rate differentials for industry sectors, other than a specialised offshore banking unit regime.46
Tax concessions are available for start-ups and certain research and development activities, including:
- refundable tax offsets for 'eligible entities' with an aggregated turnover of less than A$20 million, at a rate 18.5 per cent above the corporate tax rate from 1 July 2021;
- non-refundable tax offsets for all other eligible entities with an aggregated turnover of more than A$20 million with tiered rates applying from 1 July 2021;47
- an early-stage innovation company tax incentive, which gives investors a 20 per cent refundable tax offset for their investment and a 10-year capital gains tax (CGT) exemption where the investment in an eligible entity is held for more than 12 months;48 and
- the start-up employee share scheme rules,49 which exempt the provision of shares or options to employees of start-up companies under compliant schemes.
Australia does not have corporate minimum capitalisation requirements. Thin capitalisation rules exist that prevent base erosion by disallowing debt deductions where the debt-to-asset ratio of Australian operations exceeds prescribed debt limits. Higher limits apply to banks and financial entities.
A 'general entity'50 calculates its 'maximum allowable debt' under one of three elective methods.
The predominant method is the 'safe harbour debt amount' (SHDA). This method allows an entity to be funded by debt up to an amount equalling 60 per cent of the average value of the entity's Australian assets calculated based on the accounting balance sheet, subject to certain adjustments.51
Entities geared above the SHDA may apply the arm's-length debt test (ALDT) or worldwide gearing debt test (WWGT).
To rely on the WWGT, foreign-controlled entities must have audited accounts demonstrating that less than 50 per cent of the group's assets are in Australia.52
The ALDT sets the debt limit based on a hypothetical amount that could be borrowed given certain assumptions, including that the entity does not have any explicit or implicit credit support. In practice, the ALDT is highly subjective and requires significant work to document.
In contrast, the WWGT permits gearing of Australian operations up to the level of the worldwide group. It is based on audited accounting values and is more objective than the ALDT.iii Common ownership: group structures and intercompany transactions
Consolidation requires the head company and subsidiary entities to be Australian tax residents.55 Australian-resident wholly owned subsidiaries of a common foreign holding company may form a multiple-entry consolidated group.
A consolidated group is treated as a single entity for income tax purposes. Tax attributes are pooled and transactions between members are disregarded, permitting the transfer of assets between wholly owned entities with no income tax implications.56 For this reason, group restructures generally make extensive use of the consolidation regime.
Assets can also be transferred tax free between an Australian entity and a foreign resident free from CGT, provided that the transferor and transferee are members of the same wholly owned group.57Ownership structure of related partiesTax grouping and loss sharing
Consolidation is necessary to pool tax losses in a group.58
On joining, all of the entity's carry-forward losses that could have been used outside the group at the time of joining are transferred to the head company.59 Integrity rules operate to prevent losses from being used at a greater rate than they would have been without consolidation.60Accruals taxation
Australia has robust and broad-based controlled foreign company (CFC) rules,61 which capture passive and 'tainted' service and sales income. The CFC rules are considered to meet the 'best practice' base erosion and profit shifting (BEPS) criteria.62
Planning opportunities are limited and mostly involve ensuring that Australian entities do not control the CFC or that 'active income' makes up 95 per cent or more of the CFC's income,63 although this is difficult in light of an associate inclusive in-substance control test.64
Australia has repealed its foreign investor fund (FIF) rules. The FIF rules formerly taxed accrued gains on 'portfolio' interests.65Domestic intercompany transactionsGeneral deductibility
Although there are no general domestic transfer pricing rules, limitations exist on the deductibility of related-party expenses. Excessive payments may be characterised as distributions of profit and, consequently, are not deductible.66
Limitations also exist on the deductibility of related-party expenditure. For example, deductions for related-party expenditure are not generally available until the period in which the recipient treats the receipt as assessable.67MIT non-arm's-length income
The MIT rules uniquely contain specific non-arm's-length income (NALI) rules.68 If the Commissioner determines an amount to be NALI, the trustee is taxed at the corporate rate on the excess of the NALI amount over the hypothetical arm's-length amount minus deductions that are referable only to the amount of the excess.69 The NALI rule is an integrity rule aimed at preventing the abuse of the 15 per cent WHT rate. It will generally apply to businesses that derive rental or similar passive income such as property funds or infrastructure assets.International intercompany transactionsTransfer pricing
Australia has a robust international transfer pricing regime that is supported by the application of the DPT to SGEs and country-by-country (CbC) reporting obligations.70 The transfer pricing regime operates on an arm's-length principle and permits the ATO to adopt a reconstruction approach to determining the impermissible transfer pricing benefit.71
The 2017 Chevron case 72 provided judicial guidance on applying the transfer pricing provisions to cross-border related-party financing. The court held that an arm's-length rate of interest should not be determined as if the subsidiary were a company separate from the rest of the group. This will have significant implications for pricing cross-border debt in multinational groups as the subsidiary will need to account for the group's creditworthiness. The principles outlined in Chevron were reaffirmed in the 2019 Glencore case in which Glencore succeeded against the ATO at first instance in 2019 and on appeal in 2020.73Information exchange
Australia also participates in information exchange under both the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) regimes.74CGT
Australia's CGT regime applies to related-party transactions.
Australian residents are subject to CGT on a worldwide basis.
Foreign residents are subject to CGT only on assets that are 'taxable Australian property',75 including real estate in Australia or CGT assets used in an Australian PE.
Integrity rules exist to deem a transfer to be at market value if the transaction is not at arm's length.76
Tax is payable on net capital gains. A capital loss may be offset against capital gains or carried forward to later income years. Companies are entitled to carry forward capital losses provided that they have either substantially maintained the same ownership and control or carried on the same business.77
Australia does not currently have a permanent tax or capital loss carry-back regime; however, a covid-19-related measure that has been introduced is the temporary loss carry-back measure allowing eligible corporate entities to carry back losses made up to and in the 2021–2022 income year.78
The operation of the CGT rules means that cross-border related-party transactions might have Australian tax implications where the vendor is an Australian entity or where the asset is land or an interest in a land-rich entity. No CGT implications arise for foreign entities where the asset is not land or an interest in a land-rich entity.iv Third-party transactions
The taxation implications of third-party transactions depend on whether the transaction is on revenue or on capital account, which is a question of fact. This subsection addresses third-party transactions on capital account, generally including divestment of investments and similar transactions.Sales of shares or assets for cash
Australian companies may reduce their capital gains from disposals of shares in a foreign company under a participation exemption.79
The exemption requires the Australian company to have held a 'direct voting percentage' of 10 per cent or more in the foreign company throughout a 12-month period that began no earlier than 24 months before the time of disposal. Under the exemption, the gain is reduced by a percentage reflecting the foreign company's 'active business' asset use. The relevant percentage reduction is calculated by a market value or book value method at the taxpayer's election.80 If that percentage is greater than 90 per cent, the gain is reduced by 100 per cent.
There is no other relief on a cash sale of assets.Tax-free or tax-deferred transactionsScrip for scrip
In a takeover involving the issue of some shares, a vendor may be able to defer paying CGT until a later CGT event to the extent of the scrip consideration. The exchange should be structured carefully so that the same arrangement is offered to all shareholders of the same class.81 This rollover does not permit an exchange of shares for units, or vice versa; however, it does permit a rollover of redeemable preference shares (RPS) even if they are treated as debt for income tax purposes. Importantly, if RPS are 'voting shares' for the purposes of the Corporations Act 2001, they must be able to participate in the exchange.82
There is no specific rollover available for the exchange of tangible or intangible assets other than in specific circumstances (e.g., when the asset is damaged).83
Rollover relief may apply to the interposition of a new holding company between a company and its shareholders84 where interests in a newly incorporated holding company are issued to all of the shareholders in exchange for all of their interests in the original company (and nothing else).85Demergers
An entity may choose to roll over a capital gain or loss arising from a demerger of entities from a group provided that a number of eligibility conditions are satisfied.86
One criterion is that shareholders of the head entity must acquire shares in the demerged entity and nothing else (of value). The ATO previously accepted that demerger tax relief would apply where the shareholders of the demerged entity sold their shares after the demerger (e.g., under a takeover) provided that the demerger was not conditional on the subsequent share sale occurring.
The ATO's Taxation Determination TD 2020/689 gives the following examples:
- demerger tax relief will be available where a head entity is sold after a subsidiary is demerged pursuant to a takeover bid that is legally and commercially independent of the demerger;90 and
- where a subsidiary is demerged with the intention of preparing the head entity for sale, the 'nothing else' requirement will not be satisfied (where it can be objectively inferred that the demerger was unlikely to have occurred except to prepare for the head entity's sale).91
The ATO has previously expressed the view to particular taxpayers that relief is not available where a demerger is followed by a share sale as the nothing else requirement is not met, in some cases even absent conditionality between the two.92 Now, in TD 2020/6, the ATO expresses as a public view applicable to all taxpayers that a restructuring is not necessarily confined to the steps or transactions that specifically deliver the ownership interests in the demerging entity to shareholders, but it may include previous or subsequent transactions (even if they occur several months apart), regardless of whether those transactions are legally independent of one another, are contingent on different events or are transactions that might not occur. This wider view of a 'restructure' is expected to make it more difficult for entities to satisfy the demerger tax relief provisions, such as where a head entity or subsidiary is sold after a restructure or a capital raising is undertaken as part of a restructure.93
There continues to be no public guidance or explanation for the ATO's narrowing interpretation of the demerger tax relief provisions.Review of rollovers
In December 2020, the Board of Taxation released a consultation paper94 as part of its review into the existing CGT rollover framework. The Board provided interim written advice to the government on 25 March 2021 and will submit a final report by 22 April 2022.Corporatisation
Rollover relief will be available where an individual, partner or trustee disposes of the assets of a business to a wholly owned company.95 This is commonly done as part of an exit from a business operated as a sole trader or through a discretionary trust.
The balance sheet of the business must be managed to ensure that the liabilities assumed by the company do not exceed the sum of the market value of precluded assets96 and the cost base of the non-precluded assets. There is frequently difficulty in satisfying this requirement where the value of the business is largely internally generated goodwill.Intangibles
There is no specific rollover for intangible assets.Liquidations
Liquidation dividends sourced in profits are assessable as dividends. Liquidation proceeds not attributable to profits are treated as capital proceeds of liquidation and may trigger a capital gain. No specific relief is available.97International considerations
Two noteworthy issues arise in relation to third-party cross-border transactions.
First, key integrity rules around interest WHT-free financing apply only where the counterparty is an unrelated non-resident financier. For example, the public offer test is deemed to have been failed if the financier is a related third party.98
Second, clawback rules can apply to the sale of shares. CGT Event J1 applies where there was previously a rollover of a capital gain on transfer of an asset between members of a wholly owned group. The tax liability is triggered if the transferor and transferee cease to be wholly owned. Any share sale structuring should take account of this possibility.99v Indirect taxes
The GST is a broad-based (value added) tax of 10 per cent applying to most goods, services, and other items sold or consumed in Australia. A number of goods and services are exempt from GST – in particular many medical goods and services, most 'basic' food and exports.
Registration for GST is mandatory for Australian businesses with a GST turnover exceeding A$75,000, increasing to A$150,000 for non-profit organisations.
Non-resident entities are required to register if they are carrying on an enterprise and have a GST turnover from sales connected with Australia exceeding A$75,000.
The 'Netflix tax' imposes GST on sales of imported services and digital products to purchasers that are 'Australian consumers',100 being an Australian resident who either:
- is not a business registered for GST; or
- purchases the product for non-business use.
Several other indirect taxes in Australia are limited to specific industries or products. For example, a luxury car tax of 33 per cent is imposed on vehicles over the relevant inflation indexed threshold,101 and a wine equalisation tax is imposed at 29 per cent of the wholesale value of wine, payable by entities making, wholesaling or importing wine into Australia.
Fuel tax credits provide businesses with a credit for excises or customs duty that was included in the price of fuel used in machinery, plant, equipment and vehicles travelling off public roads.102