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By Gary D. Sprague, Esq.
Baker & McKenzie LLP, Palo Alto, CA
On September 16, 2015, the Australian government introduced into Parliament Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, which contains, among other items (including the implementation of country-by-country reporting), the proposed legislative language to implement Australia's version of the United Kingdom's diverted profits tax. The bill was accompanied by a lengthy Explanatory Memorandum ("EM") issued by the Treasurer which provided considerable additional detail as to the intended operation of the legislation.
This so-called Multinational Anti-Avoidance Law ("MAL") is an addition to the general anti-avoidance sections of Part IVA of the Australian Income Tax Assessment Act 1936. The expressed purpose of the law is to "counter the erosion of the Australian tax base by multinational entities using artificial or contrived arrangements to avoid the attribution of business profits to Australia through a taxable presence in Australia." As noted below, the proposed legislation includes a test whether the taxpayer had "a principal purpose" to avoid tax, which is intended to reflect the 2014 OECD report on Action 6 of the BEPS Action Plan, dealing with "preventing the granting of tax treaty benefits in inappropriate circumstances." By placing this legislation in the general anti-avoidance rules, the intention is to exclude assessments under the MAL from any protection under Australia's income tax treaties.
The legislative materials speak in terms of "abuse" and "contrivance." What the legislation really does, however, is impute an Australian permanent establishment ("PE") in certain cases where the Australian Tax Office ("ATO") is not pleased with commercial arrangements in the group taking place completely outside Australia, even those entered into by enterprises that are clearly qualified residents of their jurisdiction for treaty purposes. It would be more accurate and transparent to describe the MAL as a new PE standard for certain remote sales transactions, operating independently of Australia's tax treaty obligations. The MAL can apply even if the nonresident enterprise and any affiliated enterprise operating in Australia are fully compliant with the treaty PE standard for direct tax nexus of the nonresident, and even if the compensation paid to the Australian affiliate is completely compliant with the arm's-length principle. This legislation operates from the premise that it is possible to have a structure that (otherwise) complies with all aspects of the law, and is priced on an arm's-length basis, but still results in the deeming of a notional PE as a consequence of an objective principal purpose of reducing tax.
The point of the MAL seems clear -- the Australian government is seeking to tax offshore profits earned by certain enterprises that employ a remote sales structure. It seems clear that the Treasury had particular taxpayers in mind, not just types of transactions, when the rules were developed. The EM expressly states that the MAL "is targeted at 30 large multinational companies," although it is possible that "up to 100 companies may need to review their arrangements to make sure they comply with the new law." Apparently on further reflection as to the scope of the legislation's reach, the Treasurer commented on the release of the draft legislation that "1,000 companies will need to consider the new rules if they have economic activities in Australia but book their Australian sales revenue offshore."
The reason the MAL really is a new PE standard as opposed to an anti-abuse remedy is that the circumstances that cause the MAL to apply can exist without the taxpayer having taken an abusive interpretation of any Australian law. The MAL applies if two circumstances exist together. The first circumstance essentially exists if the nonresident enterprise makes remote sales into the Australian market with the assistance of a related Australian enterprise. The statute sets out five elements to describe the case of remote sales that are potentially subject to the MAL: (1) a nonresident makes a supply to an Australian customer; (2) activities are undertaken directly in connection with the supply; (3) some or all of those activities are undertaken by an Australian affiliate or Australian PE of an affiliate; (4) the nonresident derives ordinary or statutory income from the sale; and (5) some or all of that income is not attributable to an Australian PE of the nonresident.
The second circumstance that must exist for the MAL to apply is that the enterprise must have entered into the arrangement for a principal purpose of obtaining a tax benefit. The definition is worded to make relevant an Australian tax benefit or a reduction of the enterprise's or a related person's tax liability under a non-Australian tax law. The EM notes that whether the principal purpose requirement is met is an objective inquiry; the subjective motives of the participants are irrelevant. In an interesting point, the EM states that if the enterprise has received professional advice on whether a structure will avoid creating an Australian PE, then that advice may "in certain circumstances" be regarded as evidence of a principal purpose to obtain a tax benefit. This is a product of Australian case law that has attributed a taxpayer's professional adviser's purpose to be the taxpayer's purpose, for the purposes of Australia's existing general anti-avoidance rules.
Finally, whether the MAL will apply to a particular structure is to be assessed with regard to three additional matters, namely, the factors considered for the purposes of Australia's general anti-avoidance rules, the extent to which the relevant activities that contribute to bringing about the contract for the supply are performed by the nonresident enterprise, the Australian affiliate, or by another entity, and the result under foreign law of the structure.
The effect of these rules essentially is to constitute a new nexus rule for certain remote sellers. The MAL does not seek to interpret the existing PE rules. It is clear that the MAL can apply even if the Australia-based activities do not constitute a PE under Australia's tax treaties. It even seems possible to fall under the MAL if the on-shore activities would not create a PE under the revised and expanded PE standards proposed under Action 7 of the BEPS project. The MAL also is not a transfer pricing rule, per se. There is no element of the determination of whether the MAL applies that depends on whether the payments made to the Australian affiliate satisfy the arm's-length principle. There is no element of the MAL that is based on any aspect of the group's tax reporting in Australia not being compliant with all existing laws.
The consequence of being subject to the MAL is that the nonresident's Australian tax liability will be determined under an "alternative postulate," which is the "particular tax effect that `would have occurred' if the scheme was annihilated, or `might reasonably be expected to have occurred' had the taxpayer entered into a different arrangement that was a reasonable alternative to the actual scheme." In most cases, it appears that "alternative postulate" would contemplate that the nonresident enterprise would be treated as making the supplies through a notional Australian PE.
There is little guidance in the legislation itself or the EM as to how profits would be attributed to the notional PE, other than the clear intention that any withholdable payments made by the nonresident entity could be subject to Australian withholding tax, if those payments were allocable to the revenue allocated to the PE. The EM suggests that the profits attributable to the notional Australian PE should be determined in accordance with the arm's-length principle, but there is no reference to the Authorized OECD Approach ("AOA") to attributing profits to a PE. One might question whether the profit attribution analysis would be handled in accordance with the AOA due to a statement in the EM that is intended to describe the scope of activities of the notional PE. The EM states that "the notional permanent establishment could include all of the activities of the Australian-based entity." Combining the functions, assets, and risks of the separate Australian entity with those of the notional PE of the nonresident enterprise seems to confuse the separate and distinct taxable entities of the nonresident operating through a notional PE and the separate taxable entity that is the Australian affiliate. Perhaps the follow-on work to be done under Action 7 dealing with profit attribution to PEs under Article 5(5) and Article 7 of the OECD Model Tax Convention will provide some guidance in determining the consequences of becoming subject to the MAL.
So what does this mean for the 30 targeted companies (and their possible 100, or 1,000, fellow travelers)? The government intends the MAL to be outside the scope of Australia's tax treaties. Perhaps a brave taxpayer will seek treaty PE protection by challenging the notion that a structure can be abusive if it is fully compliant with all applicable domestic legislation and tax treaties. Until then, there is no reason to believe that the ATO does not intend to enforce the MAL against the targeted taxpayers. The more interesting question from the perspective of the development of broader international tax law is whether other jurisdictions will now be encouraged to follow the lead of the United Kingdom and Australia to rewrite nexus and source rules outside the framework of the OECD Model Tax Convention treaty network, which heretofore has been so successful in harmonizing the international tax landscape.
This commentary also appears in the November 2015 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.
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