International Tax
Multinational tax integrity package
The Budget includes details of three measures announced by the Australian Labor Party during their election campaign “to ensure multinationals pay their fair share of tax”. This follows an August 2022 Treasury consultation paper and submissions in response to that paper by EY and others. It is proposed to:
- Change the thin capitalisation interest deduction limitation rules
- Introduce a new rule limiting multinational enterprises (MNEs) ability to claim tax deductions for payments relating to intangibles and royalties that lead to insufficient tax paid
- Introduce a series of ‘enhanced’ tax transparency measures.
A further election announcement to implement a public registry of beneficial ownership to improve transparency on corporate structures, to show who ultimately owns or controls a company or legal vehicle, is yet to be developed.
Consultation is currently ongoing concerning the election commitment to implement the OECD BEPS Two-Pillar solution which includes the 15% global minimum effective tax rate on profits of large MNEs.
MNE package - Amending Australia’s interest limitation (Thin Cap) rules
The Budget confirmed the Government’s election commitment to amend the thin capitalisation rules to limit debt deductions of MNEs to 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA) in line with the OECD’s recommended approach under the BEPS program. The current thin cap rules provide 3 tests for MNEs, being:
- The safe harbour test (which broadly disallows debt deductions to the extent that debt exceeds 60% of an entity’s Australian assets)
- The arms’ length debt test (ALDT) (which considers the amount of debt that ‘could’ have been borrowed by an independent party carrying on the same operations as the Australian entity and is widely acknowledged to be compliance heavy and uncertain)
- The worldwide gearing test (which allows an entity’s Australian operations to be geared equivalently to its worldwide group).
The Budget indicated the following key changes to the thin cap rules:
- The safe harbour test and worldwide gearing test will both be replaced with earnings-based tests, specifically:
- The safe harbour test will be replaced with an earnings based test that will apply to limit an entity’s debt deductions to 30% of EBITDA. Denied debt deductions (i.e., debt deductions above the 30% EBITDA ratio) can be carried forward and claimed in a subsequent income year (up to 15 years)
- An earnings based group ratio will apply to allow an entity in a group to claim debt deductions up to the level of the worldwide group’s net interest expense as a share of earnings (which may be in excess of the earnings based tests’ 30% EBITDA ratio). This will replace the worldwide gearing test
- While it will be retained as a substitute test, the ALDT will apply only to an entity’s external (third party) debt, resulting in debt deductions for related party debt being denied under this test.
The Budget confirms that financial entities (and presumably authorised deposit-taking entities) will not be subject to the amended thin cap rules.
The amended thin cap rules will apply to income years commencing on or after 1 July 2023. This is a very tight timeframe for taxpayers to prepare for the amendments.
Since there is no mention of transitional rules, it appears that existing debt arrangements will not be grandfathered. As such, borrowers need to urgently review the impact of these new rules on interest expenses arising on existing debt structures which up until now may have been fully deductible.
The Budget is silent on a number of key points, including whether:
- A carry forward of excess debt capacity (where an entity’s actual net debt deductions are below the maximum permitted) will be made available. As such, it appears the proposed rules will not allow for this
- Any carve outs will be provided for large scale infrastructure and real estate projects.
The insurance industry may be excluded from being subject to the amended thin cap rules.
MNE package - Denying deductions for payments relating to intangibles and royalties paid to low or no tax jurisdictions
The Budget builds on the Government’s election commitment for an integrity measure applying to significant global entities (SGEs) which would deny deductions in Australia on related party cross-border payments relating to intangibles.
The anti-avoidance measure will apply to organisations in Australia who are SGEs (entities with global revenue of at least $1 billion) who make payments, directly or indirectly, in relation to intangibles in low or no tax jurisdictions. The measure is proposed to apply to payments made on or after 1 July 2023.
Specifically, the anti-avoidance measure will apply to payments where:
- The payments are made to jurisdictions where they are taxed at a rate of 15 per cent or less; or
- The payments are made to jurisdictions with a tax preferential patent box regime without sufficient economic substance.
The announcement contains limited detail on the proposed extent of the rule. It is unclear whether a payment for ‘intangibles’ will include circumstances where the payment is for intangibles and/or royalties, even if the payment is not so characterised or is an embedded one (such as those arrangements covered under the ATO’s Taxpayer Alerts, TA 2018/2 - Mischaracterisation of activities and payments in connection with intangible assets and TA 2020/1 - non-arm’s length arrangements and the DEMPE of intangible assets). A complementary statement on the ATO website suggests that the rules will extend to payments for advertising algorithms and customer data bases.
It is also unclear the extent to which the measure would apply to an indirect payment and the required tracing which would need to be undertaken by an Australian payer. This could result in significant compliance costs.
Further, while the measure is described as an “anti-avoidance rule”, it is unclear whether the measure will also include a purpose test and whether the measure is proposed to form part of the anti-avoidance rules in the tax legislation. This would potentially result in the rule being carved out of Australia’s Double Tax Agreements (DTA). The use of the term “anti-avoidance rule” as well as the reference to “sufficient economic substance” (a term defined in the current anti-avoidance rules) suggests the intention is to include the rule within the anti-avoidance provisions.
It is disappointing to see this measure announced in the proposed form. Australia’s tax rules already contain significant powers and anti-avoidance rules to tackle structures and behaviours to which the proposed measure is targeted at. Furthermore, the proposed measure is likely to apply to a range of normal commercial arrangements that are not tax-driven. The measure has the potential to deter investment into Australian and certainly runs contrary to limiting compliance costs for businesses conducting genuine commercial activities. The measure also has the potential to run contrary to Australia’s DTA commitments and obligations.
MNE package - Multinational tax transparency
Under the Government’s broader Multinational Tax Integrity Package, the Budget confirms the Improved Tax Transparency measures that will require certain companies to disclose information to the public for income years beginning on or after 1 July 2023.
The Improved Tax Transparency measures will require:
- SGEs to prepare for public release of certain tax information on a country by country basis and a statement on their approach to tax, for disclosure by the ATO
- Listed and unlisted Australian public companies to disclose information on the number of subsidiaries and their country of tax domicile
- Tenderers for Australian Government contracts worth more than $200,000 to disclose their country of tax domicile by supplying their ultimate head entity’s country of tax residence.
Other details (such as format and detailed content of reporting) are yet to be released.
Increased levels of Australian tax transparency for multinationals will require a strengthening of local and global tax governance frameworks. This latest requirement for companies to make their historically private tax affairs public, will enhance the necessity to ensure disclosures are supportable and based on accurate and tested data. In making the new disclosures, multinational companies will need to manage internal stakeholder expectations, particularly given local Australian disclosures may require review of global tax issues and therefore consideration and sign-off of the company’s global communications / public disclosure protocols. Increased resources may be required for companies to obtain the required information from subsidiaries and particular details of that subsidiary.
Program to expand treaty network behind schedule
The program announced in September 2021 to expand Australia’s tax treaty network to cover 80% of foreign investment by 2023 is behind schedule. The Budget reflects the DTA signed with Iceland on 12 October 2022 and the existing treaty with India has been unilaterally amended by Australian legislation.
Otherwise, there is no major update on negotiations with Luxembourg, Greece, Portugal and Slovenia nor has there been any announcement as to which countries make up the remaining four spots of the proposed ten updates in total. The lack of progress means impacted businesses may need to make representations to ensure this remains on the Government’s agenda.
