Australia: Authorities target base erosion and profit shifting

September 24, 2013

Australia’s tax landscape is changing fast. Recent months have brought new disclosure and transparency requirements, a strengthening of the existing GAAR regime and significant new transfer pricing legislation.

Disclosure of taxes paid by large companies

In February 2013, the Assistant Treasurer proposed that large businesses and multinational companies report taxes paid in Australia. This measure is designed to “encourage enterprise to pay their fair share of tax and discourage aggressive tax minimization 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 measure was passed largely unaltered by Parliament in June 2013. For companies and corporate tax entities with an annual income of AUD100m or more, the Australian Taxation Office (ATO) will be required to report details of gross income, taxable income and tax payable.

Larger companies will need to consider not only the impact of the disclosure but also the need to prepare for potential queries from the public and media in relation to their tax payable. For example, companies benefiting from concessions arising from large capital expenditure will need to ensure that their low tax levels are not misunderstood.

New transfer pricing law and revised General Anti-Avoidance Rule (GAAR)

The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013was passed by Parliament in June 2013. The new law replaces the existing transfer pricing regime and amends the general anti-avoidance rule, known as Part IVA.

The new transfer pricing rules have effect from the first income year commencing on or after 1 July 2013. The major changes are:

  • The introduction of a self-assessment regime that, in effect, requires public officers to sign-off on the appropriateness of their transfer pricing.
  • A new penalty regime linked to documentation. Although preparing transfer pricing documentation is not compulsory, failure to prepare documentation results in an entity not being able to establish a reasonably arguable position and may lead to larger penalties in the event of an ATO audit.
  • Extensive reconstruction provisions that require taxpayers to go beyond the transaction when assessing their transfer pricing. In addition, they must provide the ATO with extensive powers to substitute transactions that the ATO believes better reflects arm’s length behavior.

Businesses will need to review their existing transfer pricing arrangements for conformity with the new rules, specifically around the adequacy of documentation. Some businesses will need to undertake significant additional work to align their existing arrangements. Documentation to meet the minimum requirements must:

  • Be prepared contemporaneously (i.e. before an entity lodges its income tax return)
  • Explain how actual conditions are consistent with arm’s length conditions.
  • Explain how the selection and application of transfer pricing best achieves consistency with OECD guidelines (and the OECD Model Tax Convention for Permanent Establishments).

General Anti Avoidance Rule amended

The Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 also amended Australia’s general anti avoidance tax rule, known as Part IVA. Part IVA requires identification of a tax benefit from a scheme.

The amendments are intended to prevent courts from deciding that a taxpayer would, but for the relevant scheme, have done nothing – and so Part IVA would not apply in those circumstances.

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. The definition of a potential tax benefit has been broadened.

Therefore, this analysis will need to be undertaken more frequently and in relation to transactions that would generally be considered as “normal commercial activities.” The amendments will apply to transactions that commenced to be carried out on or after 16 November 2012.

The amendments seek to:

  • Confirm that questions over whether Part IVA applies to a scheme start with consideration of 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 concerning when a scheme falls within the “would have” or “might” categories: this needs to be resolved. 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.

Financing tasks for multinational businesses –impact of the Budget

Several measures in the May 2013 Federal Budget affect tax structuring and financing. These include:

  • Tax deductions incurred by multinational groups in Australia for funding activities by altering the thin capitalization rules
  • Deductibility of interest incurred on debt used to finance overseas investment
  • The structuring of foreign subsidiaries and investments

The intended start date is for income years starting on or after 1 July 2014.

Multinational businesses, both Australian- and foreign-owned, need to identify the risks and promptly consider the impact on their:

  • Refinancing of existing financing arrangements
  • Foreign subsidiaries’ existing capital structures
  • New funding of foreign operations

Immediate actions might involve considering restructuring of the financing and capitalization of foreign subsidiaries, and lobbying to ensure that the adjusted law deals with practical issues and challenges in the new tests. Listed businesses might also need to consider their obligations under the continuous disclosure rules.

More active ATO scrutiny of multinational businesses

Australia’s Commissioner of Taxation, Chris Jordan, has affirmed the tax administration’s commitment to supporting the government’s anti-base erosion efforts.

“I want business to know clearly that, if they choose questionable or very aggressive practices, there will be consequences,” he said in a recent speech. “The ATO has compliance tools to discourage inappropriate practices and I’ll direct my officers to continue to make full use of the toolkit.”

The full version of this article is published in EY´s Global Tax Policy and Controversy Briefing, issue 12 (PDF, 7.39 MB)

Questions or comments? Contact us

EY refers to one or more of the member firms of Ernst & Young Global Limited (EYG), a UK private company limited by guarantee. EYG is the principal governance entity of the global EY organization and does not provide any service to clients. Services are provided by EYG member firms. Each of EYG and its member firms is a separate legal entity and has no liability for another such entity's acts or omissions. Certain content on this site may have been prepared by one or more EYG member firms.