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By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
At 11 p.m. on Thursday, December 3, 2015, the Australian Parliament was called into special session to consider and vote on a proposed Multinational Anti-Avoidance Law (MAAL). With alacrity, both houses of Parliament approved the bill that night. Royal assent followed within a week. The law became effective for income earned starting January 1, 2016, merely four weeks after Parliamentary approval.1
This commentary will reflect on the challenges for good tax administration raised in cases where a national Parliament enacts legislation specifically designed to encourage taxpayers to restructure their business models in the country in a certain way, but with which it is impossible for those taxpayers to comply by the effective date.
The MAAL expressly applies only to the largest groups, as its statutory threshold is A$1 billion of "annual global income." In announcing the legislative proposal, the then Australian Treasurer, the Hon. Joe Hockey, made it clear that the legislation was targeted at "multinationals" (but presumably not Australian ones).2 Mr. Hockey ramped up the pressure through public comments indicating the strong intention of the government to pursue enforcement actions under the MAAL.3
The law is part of the anti-avoidance provisions of the corporate income tax law. This is significant, as this anti-avoidance foundation of the new law provides the basis for the government's view that the application of the MAAL is not limited by the terms of any of Australia's numerous tax treaties. Further, the anti-avoidance provisions allow for a subjective assessment of a taxpayer's intent, and the taxpayer carries the burden to disprove the Australian Tax Office's (ATO's) determination of the objective dominant purpose for entering into the arrangement.
This enforcement orientation was magnified through the provision of noticeably stiff penalties. The prescribed maximum penalty of up to 120% of the assessed tax is specifically designed to be twice what would otherwise be payable by taxpayers undertaking schemes subject to the general anti-avoidance rules. As a consequence, the penalties are higher than most other penalty provisions in Australian tax law. This arsenal of enforcement mechanisms showed that the Australian Parliament meant business.
Taxpayers immediately began to consider various structural alternatives to their current Australian sales operations. The legislation is focused on commercial structures where a nonresident makes a supply of goods or services directly to Australian purchasers through group structures where "activities are undertaken in Australia directly in connection with the supply" by an Australian entity associated or commercially dependent on the foreign supplier. The two most obvious restructuring alternatives which will take the Australian operations outside the scope of the new law are: (1) to convert the local sales operations into a reseller of the group's goods or services to the Australian market, so as to eliminate the direct supply from a nonresident entity; or (2) to reduce the amount of sales and marketing activity conducted in Australia, with the goal of falling below the threshold of onshore customer facing activity "in connection with the supply."4
To be compliant by the January 1, 2016, effective date, however, a group would have needed to consider its alternatives, make a restructuring decision, and implement that decision within four weeks of Parliament's approval. It was clear to all business observers that this timeline was impossible to achieve for essentially all relevant taxpayer groups. Perhaps a start-up with a handful of employees could react that nimbly; it was impossible for the major multinationals that were the targets of the law. The restructuring decision to reduce the amount of sales and marketing activity conducted in Australia normally would require making Australian personnel redundant. Australia's employment laws are often rigorous and difficult to navigate, especially in a redundancy context. The alternative approach of restructuring a major group's commercial transactions for (and solely for) the Australian market also is a complex and costly exercise. All customer contracts would need to be assigned to the Australian entity, financial systems reengineered (a significant undertaking in billion-dollar groups), local personnel trained in their new responsibilities, terms and conditions of new contracts to be governed by Australian law reviewed by the legal team, financial programs such as foreign exchange hedging, inventory financing, and similar arrangements reviewed and renegotiated with the counterparties, and the like.
Taxpayers were anxious to comply. But it couldn't be done in four weeks.
Taxpayers desire clear rules, fairly administered. Over the years, the ATO has shown itself to be one of the more transparent tax administrations in the world. The ATO consistently has been an early adopter of taxpayer engagement processes, such as the Advance Pricing Agreement program, that are effective tools of good tax administration. But here the ATO was given a challenge: how to administer a new law with very subjective standards, enacted in a highly politicized environment, with which it is impossible to comply for an extended period after the law comes into effect.5
The result is an innovative approach expressed in the recently finalized "MAAL client experience roadmap" (Roadmap).6 The Roadmap expressly recognizes that many groups were not able to restructure their operations by the effective date. In fact, the Roadmap expressly states that the ATO intends to "work with those taxpayers to restructure their operations in Australia to comply with the new law." The proposed engagement process is welcome, in that it provides a path to reach certainty on the Australian tax affairs of the group, through what appears to be the application of normal arm's-length principles applied to the actual facts of the group's Australian operations.
Before the substance, though, a little public relations work. In Mr. Hockey's words, those subject to the law are "thieves."7 In the Roadmap, however, these groups are relabeled as ATO "clients" and the proposed tax agency review of a taxpayer's affairs and the taxpayer/agency dispute resolution process rebranded as a "client experience."
Based on a reading of the Roadmap, one possible outcome of the "client experience" is that the taxpayer and the ATO may enter into a Settlement Deed for the 2016 year reporting an "appropriate" amount of tax, even if a commercial restructuring has not taken place, as long as the details of the restructuring plan are sufficiently concrete so as to provide guidance to the ATO as to the taxpayer's future commercial and compliance position. While this point will not be confirmed until taxpayers actually proceed through the Settlement Deed process, it is understood that the "appropriate" amount of taxable income is that amount which would be reported under the proposed, and necessarily hypothesized, restructured operations. In this regard, the ATO expects an arm's-length profit to be reported by the Australian entity which reflects the functions, assets, and risks of the Australian operations under the proposed commercially restructured operations.
This is the innovative part of the Roadmap. The ATO has taken into account the fact that the affected taxpayers simply cannot, in any near-term horizon, enter into those business structures which Parliament encouraged companies to adopt. The hypothesis that a taxpayer may be considered compliant if it agrees to report an amount of income "as if" the taxpayer had indeed achieved the intended reorganization is an unusual approach to tax administration. In light of the many administrative challenges inherent in this challenging new law, taxpayers certainly welcome that accommodation.
Since the 2016 accommodation seems to be a win-win for both taxpayers and the ATO, why shouldn't taxpayers be able to agree with the ATO to follow the same hypothetical restructuring for years after 2016?8 An actual forced restructuring will cause business inefficiencies, especially if the group is required to change its commercial structure only in the Australian market. The costs incurred will produce no business benefit. Yet the income to be reported, and the Australian corporate tax paid, would be the same regardless whether the taxable income is reported on the tax return of an entity that has been restructured as a reseller, or of an entity acting commercially as a sales and marketing service provider but which accepts as its obligation under the MAAL to report an amount of income exactly equal to that which it would report if it in fact had restructured as a reseller. The relevant transfer pricing would be supported in the normal way, through the use of comparables that reflect the economic comparability factors of the hypothesized restructured sales activities.
We expect that business will make this suggestion to the ATO, once companies begin to engage in discussions with the ATO under the Roadmap. In my view, extending this accommodation for years after 2016 would be a further example of ATO's desire to provide reasonable administrative solutions for groups seeking to comply with Australia's tax laws.
This commentary also appears in the March 2016 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Nauheim and Scott, 938 T.M., U.S. Income Tax Treaties – Income Not Attributable to a Permanent Establishment, Walker, 7010 T.M., Business Operations in Australia, and in Tax Practice Series, see ¶7160, U.S. Income Tax Treaties.
Copyright©2016 by The Bureau of National Affairs, Inc.
1 See prior comments on the proposed legislation at Sprague, The Proposed Australian Multinational Anti-Avoidance Law -- Leapfrogging the OECD's BEPS Process to Devise a New Nexus Rule for Remote Sales, 44 Tax Mgmt. Int'l J. 712 (Nov. 13, 2015).
3 For example, in September 2015, Mr. Hockey stated, "If [multinational companies] are not paying the taxes they should, they are stealing from the community." http://www.theaustralian.com.au/national-affairs/treasury/joe-hockeys-plan-to-tax-multinational-giants/story-fn59nsif-1227515364511?sv=dd8d135d7513bb0f1f2b57119981f2a1.
4 There would seem to be a good investment and employment development opportunity here for New Zealand to establish itself as a welcome location for sales and marketing personnel focused on the Australian market.
5 The question of the taxation of foreign direct sellers into the Australian market had become highly politically charged. See http://www.smh.com.au/business/the-economy/apple-google-microsoft-cop-tax-audit-20150408-1mgsma.
6 A copy of the Roadmap is available through inquiry to the ATO. See https://www.ato.gov.au/General/New-legislation/In-detail/Other-topics/International/Combating-multinational-tax-avoidance—-a-targeted-anti-avoidance-law/.
8 It would seem that those taxpayers whose hypothetical restructuring would be to reduce sales and marketing personnel employed in Australia as opposed to establishing a reseller structure would need to actually implement the plan in order to fall outside the MAAL, as the hypothetical income to be reported in that case presumably would be less under arm's-length principles than that being reported prior to the restructuring.
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