APAC Tax Matters: 13th edition

Australia

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At a glance

  • Financing tasks for multinational businesses and the impact of the 2013 Australian Budget
  • New transfer pricing rules to combat profit shifting enacted
  • Australia’s General Anti Avoidance Rule (GAAR) amended
  • Reporting by Australian Taxation Office (ATO) of companies’ taxes raises tax transparency issues for management and boards
  • Tax consolidation changes for inbound investors

Financing tasks for multinational businesses – impact of 2013 Australian Budget

As a result of the measures contained in the 2013 Australian Federal Budget (“the 2013 Budget”) affecting financing and the structuring of cross-border business, multinational businesses with Australian operations (both Australian owned and foreign owned) face a large analysis and refinancing task, the impact of which may be felt immediately.

The measures impact tax deductions incurred by multinational groups in Australia for funding activities due to changes in the relevant thin capitalization rules. The key change is the reduction of the main safe harbour ratio essentially from 3:1 to 1.5:1 (debt to equity).

The intended start date is for income years starting on or after 1 July 2014. However, the impact is immediate as regards new financing or refinancing strategies.

Investors with high debt levels but strong underlying cash flow continue to have access to the arm’s length debt test as an alternative to the safe harbour amount. The Board of Taxation has, however, been asked to review and prepare a report by December 2014 on the operation and integrity of the arm’s length debt test.

Given the measures in the 2013 Budget, companies may wish to review whether they can use the alternate arm’s length debt test if the safe harbour is no longer sufficient. Companies may also wish to consider restructuring existing debt arrangements, adopting instruments with different risk profiles, and the possible impact and interaction of deleveraging with transfer pricing approaches and outcomes.

On a positive note, from 1 July 2014, the thin capitalization rules will not apply where debt deductions are AUD 2 million or less per annum. Inbound investors with smaller Australian operations will no doubt welcome this increase from the previous deduction threshold of AUD 250,000.

Australia’s General Anti Avoidance Rule (GAAR) amended

The amendments to Australia’s general anti avoidance tax rule, known as Part IVA, have been enacted and now have the force of law. Part IVA requires identification of a tax benefit from a scheme. The amendments are intended to prevent courts deciding that a taxpayer would, but for the relevant scheme, have done nothing such that Part IVA would not apply in those circumstances.

The amendments, which apply to transactions that commenced to be carried out on or after 16 November 2012, seek to:

  • Confirm that the starting point for evaluating whether Part IVA applies to a scheme is to consider whether any person participated in the scheme for the sole or dominant purpose of securing a tax benefit
  • Establish two different tests for determining whether a tax benefit exists: one for schemes involving tax consequences that “would have” resulted if the scheme had not occurred and the second for schemes involving tax consequences that “might reasonably be expected to have” resulted if the scheme had not occurred

There is no guidance in the Bill as to when a scheme falls within the “would have” or “might” categories. This issue needs to be resolved. Further, from a practical perspective, it is unclear how the dominant purpose test can be applied without first determining the tax benefit, given that the dominant purpose test is applied by reference to what occurred and the tax benefit in question.

From a practical perspective, taxpayers will need to rely more heavily on establishing that they have not entered into transactions with a dominant purpose of obtaining a tax benefit. Furthermore, the amendments potentially broaden the definition of what may be regarded as being a tax benefit. The relevant analysis will therefore need to be undertaken more frequently and in relation to transactions which would generally be considered as “normal commercial activities.”

ATO reporting of companies’ taxes – tax transparency an issue for management and boards

In February 2013, the Assistant Treasurer first outlined a proposal that large businesses and multinational companies should report the taxes they pay in Australia. The rationale given for such reporting was to “encourage enterprises to pay their fair share of tax and discourage aggressive tax minimisation practices”, and “allow the public to better understand the business tax system and engage in debates about tax policy”. Concerns were raised during the very short consultation phase but the government introduced a tax Bill with the proposals largely unaltered. This Bill has now been enacted and has the force of law.

Under the Act, the ATO is now required to report details of the gross income, taxable income and tax payable thereon of companies and corporate tax entities with annual income of AUD100 million or more. The ATO’s public reporting of taxes paid commences from the 2013-14 year of income. As a result, the period to be reported for companies with 31 December balance dates has already commenced. The ATO is to issue a public report after the lodgement season. The first public report is expected in late 2015.

Multinational groups may consider proactive tax disclosures to protect their reputation. This includes their tax policies, demonstrating compliance with tax reporting and tax payment obligations and other disclosures ahead of these ATO public reporting requirements. In particular, companies within multinational groups should consider whether they are sufficiently informed and ready to explain the organization’s tax profile internally and externally in order to protect the group’s brand and reputation.

New transfer pricing rules to combat profit shifting

The new transfer pricing rules have been enacted and now have the force of law. This signals an important new chapter for multinational companies with related party dealings in Australia. The rules apply to income years commencing on or after 1 July 2013.

The new law introduces a self-assessment regime, effectively requiring public officers to sign-off on the appropriateness of their transfer pricing. The penalty regime is linked to documentation. Although the preparation of transfer pricing documentation is not compulsory, failure to prepare documentation may result in an entity being unable to establish a reasonably arguable position and may lead to larger penalties in the event of an ATO audit.

Other key changes relate to the extensive reconstruction provisions which require taxpayers to go beyond the transactions themselves in assessing their transfer pricing and provide the ATO with extensive powers to substitute transactions for those the ATO believes better reflect arm’s length behaviour. The law contains provisions that effectively require a double test, where taxpayers have to assess the overall commerciality of their arrangements in addition to the pricing of individual transactions. 

The new transfer pricing rules are designed to bring the Australian domestic regime in line with international practice through a link with the OECD Guidelines. However, there are several areas where the new rules diverge from the OECD guidelines, established international practices and the historically accepted practice of the ATO.

Businesses should expect the ATO to be aggressive in their application of the new transfer pricing rules. 

Tax consolidation changes for inbound investors

Flowing from two Board of Taxation Reports, the 2013 Budget made numerous changes affecting tax consolidated groups and multiple entry consolidated (MEC) groups. A number of these have an effect on foreign inbound investors.

Also from 14 May 2013, changes to the Capital Gains Tax (CGT) rules for foreign residents include removing the ability to use transactions between members of a consolidated group to create and duplicate assets for the purpose of determining taxable Australian property.

A new review was announced to focus on other ‘systemic advantages’ obtained by MEC groups, and will consider MEC restructuring that impact CGT outcomes for foreign residents.

With the above in mind, groups should review immediate changes to transfer-down restructures which feature recent acquisition carve-outs and, if planning or implementing any new mergers and acquisition (M&A) or restructure transactions, consider other consolidation “integrity changes”.