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Sarah Blakelock and Peter Madden KPMG Australia
Sarah Blakelock is a Partner, Tax Dispute Resolution & Controversy, KPMG and KPMG Law, Australia and Peter Madden is a Partner and National Leader, International Tax, KPMG, Australia
On February 9, 2017 the Treasury Laws Amendment (Combating Multinational Tax Avoidance) 2017 and the Diverted Profits Tax Bill 2017 (”the Bills”) were introduced into the Australian Parliament to provide for a diverted profits tax (“DPT”), applying to income years commencing on or after July 1, 2017 to ensure that significant global entities are not able to avoid their tax obligations by diverting profits generated in Australia offshore.
The introduction of the Bills into the Australian Parliament follows an exposure draft of the Bills being released on November 29, 2016, and the consultation paper released as part of the 2016-17 Federal Budget in May 2016. Enactment is expected prior to July 2017, and the DPT is expected to take effect for income years commencing on or after July 1, 2017.
The proposed introduction of the DPT is the third installment in a suite of recent legislative amendments enacted by the Australian Parliament to combat multinational tax avoidance including:
Although the Bills have been introduced into the lower house of Parliament, the Bills committee of the upper house has referred the Bills to the Senate Economics Legislation Committee for inquiry and report to the upper house by March 20, 2017 with submissions closing on March 1. The reason for the referral was to allow the upper house to first consider the impact of these bills on:
The Committee issued its report on March 20, 2017, recommending that the Bills be passed without amendment. The two bills were considered and passed by the lower house of Parliament on March 21, 2017, and are expected to be considered and passed by the upper house on March 22, 2017. It is possible that the upper house of Parliament may make one or more amendments to the Bills before they are passed. This article provides commentary on the Bills in the form in which they were passed by the lower house.
The DPT aims to capture a “significant global entity,” (“SGE”) who enters into or carries out arrangements, where the principal purpose of the arrangement is to obtain a tax benefit through the diversion of profits, generated from activities in Australia, offshore. The proposed legislation focusses upon the “economic substance” of the SGE's activities in Australia. The proposed provisions will be inserted into Australia's current general anti-avoidance provisions which provides a framework for identifying schemes and tax benefits to which the DPT could apply.
During the second reading of the DPT Bills in the lower house, the Treasurer of the Commonwealth of Australia (the Hon. Scott Morrison MP) noted that the DPT provisions are “focused only on tax avoidance arrangements that are artificial or contrived” (Commonwealth, Parliamentary Debates, House of Representatives, February 9, 2017, 5 (Scott Morrison, Treasurer). The Explanatory Memorandum that accompanied the Bills indicates that there are approximately 1600 taxpayers who are part of a global group that would meet the SGE definition and have Australian income of more than AU$25 million. It is estimated that 8 percent of those 1600 taxpayers will have a high risk of the DPT applying and need to engage with the Australian Taxation Office (“ATO”) to obtain certainty on the application of the DPT, and the remaining 92 percent are likely to seek advice to confirm whether the DPT impacts current and future arrangements. The DPT is expected to raise AU$100 million in additional tax paid each year at an administrative cost of AU$1.64 million year on year for the next 10 years.
The entities most likely to be at the highest risk of the ATO seeking to apply a DPT assessment include taxpayers which are currently in a transfer pricing dispute, particularly where that dispute is not progressing within allowable timeframes. Also at risk will be entities with cross-border transactions who have not fully addressed their functional profile outside Australia (by undertaking a two sided analysis of the supply chain), taxpayers who have undertaken business restructures and taxpayers who have migrated intellectual property from Australia. Other arrangements, including cross-border leasing and borrowing from foreign “cash boxes,” may also potentially warrant consideration of the DPT.
The primary objectives of the DPT are to:
It should be noted that the Bills themselves in no way makes it clear that the DPT is to operate as a provision of last resort—which clearly leads to uncertainty as to how the DPT regime will be administered in practice by the ATO. At the time of publication, the ATO are yet to provide guidance in the form of a Law Compliance Guide or a Practical Compliance Guide as to the approach to be taken to the administration of the DPT once enacted. Absent such guidance, it would appear possible for the ATO to seek to invoke a DPT assessment, in preference to a transfer pricing adjustment.
The DPT will not be a self-assessed tax. The ATO is to initiate the process and will notify taxpayers if it considers that they may be subject to the DPT, and then make a DPT assessment where it considers able to do so.
The DPT provisions will impose a penalty tax, at a rate of 40 percent, on the amount determined to be the SGEs Australian diverted profit (the “DPT tax benefit”) obtained in income years commencing on or after July 1, 2017, even if the scheme or arrangement commenced in prior periods.
The DPT will not apply to managed investment trusts (“MITs”), certain foreign collective investment vehicles (“CIVs”), entities owned by foreign governments, complying superannuation entities and foreign pension funds. However, this exclusion does not extend to associates of such entities, which remain in scope.
The Bills will also:
The Commissioner will be able to impose a DPT assessment on an entity under the anti-avoidance provisions where the following criteria are satisfied:
It is necessary for the Commissioner to identify with sufficient particularity the scheme or arrangement that is said to have been entered into before issuing a DPT assessment. As with existing general anti-avoidance provision; the DPT measures are designed to be engaged where a DPT tax benefit has been obtained in connection with a scheme. The criteria to assess this engagement will be by reference to the following factors:
The DPT tax benefit must be obtained in connection with the scheme. As with the existing anti-avoidance provision; the ascertainment of the DPT tax benefit requires a comparison to a reasonable alternative postulate or counterfactual to that arrangement or scheme that has been identified. The enquiry is:
What would the tax outcome have been, or might reasonably be expected to have been, if the scheme had not been entered into or carried out?
In the DPT context, this would include the ordinary taxing outcomes determined by the income tax law and where relevant, the application of the transfer pricing rules (Reference to the Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 16, [1.27]). In most cases, this will require a “two-sided analysis” of the supply chain, applying an Australian transfer pricing lens to the functions, assets and risks of the activities carried out in Australia and those activities carried out in one or more other jurisdictions up the global supply chain.
Again, like the MAAL, there is a departure from Australia's existing dominant purpose test (under the general anti-avoidance provision known as Part IVA) and the adoption of the “principal purpose.” This is a lower threshold than the dominant purpose test and is yet to be tested by the Australian Courts. The principal purpose test aligns with the OECD's approach pursued in the BEPS measures and aligns with Australia's tax treaties.
Where a DPT assessment has been issued, Australia's tax treaties do not provide for the elimination of double taxation nor does the mutual agreement procedure apply.
There are three exclusions whereby SGEs can fall outside the ambit of the DPT, if it is reasonable to conclude that any one of the following tests apply:
These three tests are said to ensure that the DPT is appropriately targeted and does not impose any undue compliance burden on low risk taxpayers (reference to the Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 30, [1.77]). That said, there are nonetheless difficulties in satisfying the “sufficient foreign tax” test due to the high benchmark, complexities in determining the AU$25 million income test and sufficient uncertainty remains in respect of how the DPT will be administered in practice by the ATO. These are expanded upon below.
The DPT will not apply to taxpayers whose total “assessable income,” “exempt income” and “non-assessable non-exempt income” is less than AU$25 million. That threshold figure is also worked out by including the DPT benefit amount (reference to the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Cth) sch 1 item 13 (section 177K)). As such, to determine whether the AU$25 million income test is satisfied, it is nonetheless necessary to consider whether the application of the DPT regime, and to calculate a DPT benefit amount
The DPT will also not apply if it is reasonable to conclude that sufficient foreign tax (effectively over a 24 percent effective tax rate) has been paid (or imposed) in all jurisdictions directly or indirectly by the relevant taxpayer or its associates in relation to the scheme. Goods and services tax (and any foreign equivalents) is not included in this calculation.
This may be challenging for many groups, given that the “sufficient foreign tax” test is set at the relatively high bar of 24 percent—with a vast number of jurisdictions having regimes that will not allow this threshold to be met (Reference to the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Cth) sch 1 item 13 (s 177L)). It may also be that jurisdictions with a relatively high headline tax rate may nonetheless fail to meet this bar, for instance where there are losses brought-forward which influence the tax base. The Bill contains a power for the government to make regulations to specify the calculations of sufficient foreign tax for all or some situations. This test will require careful analysis of the tax imposed by a law other than an Australian law and in respect of non-fiscally transparent entities. The onus of proof lies with the taxpayer.
The scheme entered into by the entity reasonably reflects the economic substance of the entity's activities in connection with the scheme. An entity is covered if the entity is the ‘relevant taxpayer’ but it also captures the activities of an “associate” of the relevant taxpayer (defined in section 318 of the Income Tax Assessment Act 1936 (Cth). This includes (for example) a company that is “sufficiently influence by the primary entity,” a partner or a trust). The determination of the economic substance will be a matter of ‘fact and degree’ and involve an assessment as to the materiality of the role played by the entity in the operation of the scheme and how much income derived from the entity in the scheme (reference to the Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 37, [1.103]).
The Decision Tree provides a summary of the various steps to determine whether the DPT may apply. Although the taxpayer must only answer one of the questions as “no” (not just those relevant to falling outside the ambit of DPT on an exclusion), the onus of proof is on the taxpayer to do so.
Because of the breadth of the DPT and the operation of the Sufficient Foreign Tax Test, a range of arrangements will potentially be affected.
Key factors to look for include:
The proposed legislation makes it clear that the ATO may make a DPT assessment at any time within seven years of first serving a notice of assessment on the taxpayer for an income year.
The objectives also emphasize the need for SGEs to provide sufficient information to the ATO to allow the timely resolution of disputes, and to encourage early engagement if required.
One of the unique measures of the proposed Australian DPT legislation is the review rights once the Commissioner has issued a SGE with a DPT assessment. Once issued with a DPT assessment the SGE must pay the DPT assessment amount within 21 days of being issued the notice of DPT assessment (reference to the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Cth) sch 1 item 13 (section 177P)). However, the SGE's right to contest the DPT assessment before an independent Tribunal or Court may only be instituted 12 months after the issuing date of the notice of assessment (Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Cth) sch 1 item 44 (section 145-5). The relevant taxpayer may apply to a court to shorten this period)).
The more punitive features of the DPT Bills that are in furtherance of these goals include:
There are other integrity measures contained within various Australian taxing legislation dealing with foreign entities where attribution of income should properly be brought to tax in Australia. Accordingly, it is important to consider the potential for overlap in the proposed DPT regime and these other existing provisions, noting again that the DPT is not a measure of “last resort.”
Australia's thin capitalization provisions consider the debt used to fund the Australian operations of both foreign entities who invest in Australia and Australian entities who invest overseas. In broad terms, the rules disallow a deduction for a portion of specified expenses an entity incurs in relation to its debt finance. The provisions are engaged when the entity's debt-to-equity ratio exceed prescribed thresholds.
The DPT provisions have recognized this existing regime and are modified accordingly. The Explanatory Memorandum that accompanied the DPT bills explain that the thin capitalization modification will operate to:
In this way, double counting for this amount is avoided since the tax benefit is carved out the amount that already falls for consideration in the existing thin capitalization regime. However, the DPT nonetheless retains the ability to alter the interest rate and other terms of a debt interest, even where the thin capitalization provisions are satisfied.
If the relevant foreign entity is a “controlled foreign corporation” (“CFC”); the DPT tax benefit is reduced to the extent that the amount is attributable income of the foreign entity in respect of the relevant taxpayer or an Australian-resident associate of the relevant taxpayer (that is not a trust or partnership). In this way, there is no double attribution of the amount already accounted for under the CFC provisions.
The MAAL was enacted in late 2015 and commenced on January 1, 2016. Importantly, the MAAL (similarly to the proposed DPT) amended the existing general anti-avoidance provisions by introducing measures designed to counter the erosion of the Australian tax base by multinational entities that seek to avoid the attribution of business profits to Australia by avoiding a taxable presence in Australia, often referred to as the “sell-here bill-overseas” type structures (Economics Legislation Committee, Parliament of Australia, Canberra, 10 February 2016, 69 (Chris Jordan, Commissioner of Taxation).
The MAAL is directed at foreign entities with sales to Australian customers and some or all of the resulting income is not attributable to an Australian permanent establishment (i.e. no or limited taxable presence in Australia). Unlike the proposed DPT; there are no income attribution threshold exclusion.
MAAL is targeted at foreign entities:
The target areas, not captured by the current MAAL, that fall for consideration under the DPT scheme are broader given that it captures arrangements beyond the making of supplies to Australian customers by a foreign entity.
The other significant measure was Australia's domestic implementation of the OECD's CbCR initiative (referred to in Action 13 of the Action Plan on Base Erosion and Profit Shifting (“BEPS”)) that requires SGEs to provide one or more statements to the Commissioner of Taxation in a given financial year (Explanatory Memorandum, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015 60, [5.8]). In particular, Australia's transfer pricing regime requires SGEs (who are Australian residents for tax purposes) and foreign residents with an Australian permanent establishment to provide three key reports (reference to section 815-355(3) of the Income Tax Assessment Act 1997 (Cth)):
This reporting applies to income years starting on or after January 1, 2016.
The proposed DPT measures compliment the country-by-country regime in that a SGE may be subject to significantly increased penalties for failing to lodge these reports with the ATO within the time required and for the making of false statements within the reports themselves. In particular, consequential amendments as part of the DPT bills are proposed to uplift the current penalty regime by 100 percent to reflect the seriousness of reporting offences (see Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Cth) sch 2 items 3-6).
The Committee issued its report on March 20, 2017, recommending that the Bills be passed without amendment. The two bills were considered and passed by the lower house of Parliament on March 21, 2017, and are expected to be considered and passed by the upper house on March 22, 2017, and apply to income years commencing on, or after, July 1, 2017. It is possible that the upper house of Parliament may make one or more amendments to the Bills before they are passed.
In preparation for the Bills' passing; on February 10, 2017 the ATO published on its website that it is developing a “Law Companion Guideline” to provide guidance on some of the new concepts that are included in Schedule 1 to the DPT Bill, though this is yet to be released for consultation.
The ATO is also developing guidance on the framework that will be established to support our administration of the DPT.
For those SGEs with a relevant taxpayer in Australia, considerations should now be given to the potential impact of DPT and understand what the relevant risk factors are as there are strategies for managing DPT risk and obtain appropriate advice to manage the identified risks.
Consideration should now be whether the DPT applies and whether appropriate transfer documentation is in place.
For arrangements which potentially meet the objectives of the DPT, consideration should now be given to what information should be collated and prepared for the purposes of responding to enquires made by the ATO including documentation of:
For U.S. listed groups, it is expected that a FASB Interpretation -48 (“FIN-48”) will likely be required to be prepared considering any potential DPT risks.
Table 1 highlights key attributes of the Australian DPT and the U.K. DPT upon which it was based.
|Australia's DPT||U.K. DPT|
|Object||Aimed at ensuring the Australian tax payable by significant global entities (“SGEs”) properly reflects the economic substance of the activities that those entities carry on in Australia.||Aimed at ensuring that the profits taxed in the U.K. fully reflect the economic activity in the U.K.|
|Commencement date||Likely to be July 1, 2017||April 1, 2015|
|Where legislation sits:||Within Australia's anti-avoidance provision being Part IVA of the Income Tax Assessment Act 1936 and imposed under what will be known as the Diverted Profits Tax Act, once passed.||Finance Act 2015|
|Applies to:||Significant Global Entities, being entities with global income or consolidated group income of AU$1 billion or more that have Australian turnover of AU$25 million or more (unless the Australian turnover is less than AU$25 million because income is artificially booked offshore rather than in Australia)||Large groups (typically multi-national enterprises); achieves this by providing exemptions for small and medium-sized companies (“SMEs”) and companies with limited U.K. sales or expenses. The U.K. has no de minimis threshold.|
|When can it apply:||Applies to Significant Global Entities where there is a tax benefit, and the “a principal purpose” test is satisfied. Exclusions include: the AU$25 million Australian Income test; the Sufficient Foreign Tax test; and the Sufficient Economic Substance test. General exclusions apply for certain MITs, CIVs, foreign pension funds & complying super funds.||Applies where: a U.K. company or U.K. permanent establishment of a foreign company has a tax mismatch that arises as a result of an entity or transactions that lack economic substance (equivalent to Australian DPT); and– reasonable to assume that the activities/transactions were designed to secure the tax reduction; or– a foreign company has artificially avoided a taxable presence in the U.K. (equivalent to Australian MAAL). Note: U.K. rules are not confined to cross-border transactions.|
|Relief from double taxation||No – because Australia's tax treaties do not allow relief from double taxation where the benefit has arisen from evasion or avoidance of taxes. Likewise, the mutual agreements procedure is also not available. Although, depending on terms of the particular treaty concerned, the competent authorities may consult.||No – because DPT is a “new” tax that is neither an income, capital gains, nor corporations tax and hence does not fall within the scope of U.K.’s double tax agreements.|
|Rate of tax||40 percent, which is payable upfront.||25 percent Note: Lower rate, which then leads to differences when both U.K. and Australia apply the Sufficient Foreign Tax test.|
On March 3, 2017 the New Zealand Government released three consultation papers with proposals for dealing with BEPS. Relevantly, the consultation paper entitled “BEPS—Transfer pricing and permanent establishment avoidance” has noted that whilst the Government has not ruled out the adoption of a DPT, it would like to investigate extending the current domestic tax framework to manage the profit shifting issue by taking certain features of a DPT and combining them with the OECD's BEPS measures (BEPS—Transfer pricing and permanent establishment avoidance: a Government discussion document, first published in March 2017 by Policy and Strategy, Inland Revenue at [1.12] see http://src.bna.com/mYG). In particular, the consultation paper states that “we do not consider it necessary to go as far as the DPTs in assessing multinationals.”
The proposed changes the subject of the consultation papers include:
The consultation seeks submissions by April 18, 2017.
Sarah Blakelock is a Partner, Tax Dispute Resolution & Controversy, KPMG and KPMG Law, Australia and Peter Madden is a Partner and National Leader, International Tax, KPMG, Australia. The authors would like to acknowledge the assistance of Liam Delahunty, Director, International Tax, KPMG; Jacqueline McGrath, Senior Associate, KPMG Law, with research assistance from George Hempenstall, KPMG Law, in the preparation of this article.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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