Against a background of persistent budget deficits and an ever-growing Australian national debt, multinationals have become a convenient target of the Australian Treasury and the Australian Taxation Office (ATO). Multinational companies in Australia are expected to face a much tougher tax regime, and one which is going further than what might be expected from the OECD’s Base Erosion and Profit Sharing (BEPS) project, which the Australian Parliamentary Library has observed Australia is a “strong supporter of.”
While the Australian government has committed to cutting the company tax rate from 30 percent to what it considers an internationally competitive rate of 25 percent, company tax cuts may not be passed by the current Parliament. This is because the conservative coalition government led by Malcolm Turnbull does not control the upper House, the Senate. Alas, in the Senate the balance of power is partly held by a number of populists, who may not be seen as supporting the “big end of town” as it is known in Australia. The presence of populists, and the Opposition Australian Labor Party, which is the left-of-center party in Australia, means that measures targeting multinationals are likely to pass through the Parliament and become law.
This article will explore the implications of recent and proposed taxation law changes in Australia that are motivated fully or in part by extracting more revenue from multinationals.
Tax integrity package including a Diverted Profits Tax
In the 2016-17 Australian government budget, handed down in early May, the government announced a Tax Integrity package. The government repeatedly notes in its budget papers that “Excluding tax integrity measures, the Government is reducing the tax burden by around A$1.9 billion over the forward estimates” (i.e. over 2016-17 to 2019-20). This rider should give you a clue that tax burden is actually increasing. The tax integrity measures themselves will raise an additional $2.4 billion in revenue over the forward estimates, and that is relative to the baseline, a baseline in which revenue is growing robustly due in part to bracket creep.
Total Australian government revenue will increase from A$388 billion to A$500 billion over the forward estimates, and the tax-to-GDP ratio will increase from 23.5 percent to 25.1 percent.
By far the largest amount of revenue, some A$3.7 billion, the Australian government is expecting will come from establishing a Tax Avoidance Task Force, increasing by 43 percent the resources it devotes to, in the actual words of the budget measure, “tackling multinationals,” as if multinationals are the member of an opposing football team. This represents an additional 390 full-time staff each year. The government has indicated in the budget that the task force will undertake “enhanced compliance activities.”
Sydney Morning Herald economics editor Ross Gittins has questioned whether this increase in resources will bring about the purported extra revenue. He considers the extra staff could just make up for recent staffing cuts. Also, he notes several of the items in the Tax Integrity package do not have revenue estimates attached to them. Gittins has also suggested that the Australian treasurer is simply talking tough, and purported additional revenue will not materialize. However, there are reasons not to doubt the government’s revenue estimates and its resolve to extract that revenue from multinationals. As will be discussed below, a feature of Australia’s crackdown on multinationals is to give the ATO a legal advantage in dealing with multinationals.
In the 2016-17 budget, inspired by a similar tax introduced in 2015 in the U.K., the Australian government also announced a new Diverted Profits Tax (DPT), targeting companies which allegedly shift profits to lower tax jurisdictions through related-party transactions. The Australian government’s DPT, labeled the Google tax by Australian media, in combination with the Multinational Anti-avoidance Laws was announced in 2015.
If it is passed by the Australian Parliament, the DPT will apply from July 1, 2017. A penalty tax rate of 40 percent, compared with the statutory rate of 30 percent, will apply where the ATO considers “it is reasonable to conclude based on the information available at the time to the ATO that the arrangement is designed to secure a tax reduction.” The test is whether there is “insufficient economic substance” to a related party transaction. This gives the ATO a lot of discretion and opportunity for mischief. As PwC has observed, the proposed law reverses the onus of proof. It also goes beyond what is required under the OECD’s BEPS project.
Hybrid mismatch rules
As part of the 2016-17 budget, the Australian government also committed to implementing the OECD’s updated Transfer Pricing Guidelines, and, consistent with the BEPS Action Plan, to targeting so-called hybrid mismatch arrangements, whereby companies take advantage of differences in the tax treatment of financial instruments and transactions between jurisdictions. The differences that companies take advantage of may relate to, for example, the tax deductibility of dividend payments or the legal status of a particular company in different jurisdictions.
There is a lot of uncertainty around this measure and it is currently still subject to further policy development work, and it would not come into effect until July 1, 2018. Actions taken against hybrid arrangements could include the denial of tax exemptions for dividends or other payments if they are treated as deductible in another jurisdiction.
PwC foresees “significant difficulties” for the Australian government in drafting the legislation so that it is not excessive in scope. Deloitte has noted that the OECD hybrid mismatch rules “involve an unavoidable degree of coordination and complexity.” This comment was regarding the imported mismatch rule, which is designed to prevent companies from avoiding the hybrid mismatch rules through transactions involving a jurisdiction which has not implemented the rules. The Australian Board of Taxation, the government’s independent advisory board on taxation, considers “the imported mismatch rule could present considerable compliance challenges for taxpayers and will be difficult for the ATO to administer effectively.”
The uncertainty around the precise rules means it is difficult at this time to assess what impacts the changes will have, but it seems likely they would add to adverse impacts of other measures targeting multinationals that collectively reduce the attractiveness of Australia as a foreign investment destination. The compliance costs of the measure are likely to be significant, for both companies and the ATO, as they will need to stay well informed about the taxation treatment of different financial instruments and transactions in different countries.
As one of the country’s most strongly committed to BEPS, Australia has entered into BEPS-consistent agreements for the automatic exchange of tax information with a range of jurisdictions. Automatic information exchange of financial account information has been facilitated by the Australian treasurer signing, along with relevant ministers in 93 countries, including the U.K. and the Cayman Islands, a Multilateral Competent Authorities Agreement (MCAA) in this regard. From an expected start date in September 2018, under a Common Reporting Standard (CRS), the ATO will begin automatically sharing financial account information with other countries’ tax authorities on the financial accounts of foreign residents. The ATO will compel financial institutions to provide this financial information on foreign residents, who will have to declare their tax file numbers to Australian financial institutions. The ATO will benefit by being able to access information on the foreign balances and investment earnings of Australian residents.
Australia already has an automatic information exchange agreement with the U.S.: the Foreign Account Tax Compliance Act (FACTA). The CRS is based on FACTA, and the MCAA will allow the extension of the automatic exchange of information to a wider range of countries. Australia has also signed up to an MCAA for the exchange of country-by-country reports on the operations of multinationals.
Multinational Anti-avoidance Law
Measures announced in 2015 included the doubling of penalties for tax-avoidance schemes, country-by-country reporting requirements whereby information and business activity and tax paid in each tax jurisdiction must be provided to the ATO, and the Multinational Anti-avoidance Law (MAAL) which took effect on Jan. 1 this year. The MAAL is designed to capture taxes from 30 companies which are earning profits from transactions in Australia but which do not have a physical office – that is, a taxable presence – in Australia, which would include a range of multinational selling online to Australia. According to EY, these rules are “broader in scope than previously announced.” The rules potentially apply to more than 100 multinationals operating in Australia.
Also, the rules are contrary to the fact that the permanent establishment basis for taxation is an OECD principle. A critic of multinationals’ tax practices, Australian transfer pricing expert Martin Feil, has identified this as a problem with Australia’s MAAL, noting, regarding the 30 companies in question: “It’s hard to see how they could be penalised until and unless the permanent-establishment principle is amended by the OECD.”
So the MAAL appears very poorly designed, and the ATO may face substantial difficulties taking action under it, so perhaps this will not pose great difficulties for multinationals in Australia.
The Australian government recognizes that Australia’s current company tax rate of 30 percent is too high and deters investment, particularly foreign investment on which Australia is heavily reliant to fund its current account deficit. This is why the government intends to cut the company tax rate to 25 percent over 10 years. Even if it were cut to 25 percent, which is looking increasingly unlikely given the political environment, it would still be uncompetitive with a range of economies, including the U.K., Hong Kong and Singapore, for example.
At the same time as the Australian government is proposing to cut the company tax rate, it is also increasing the cost of business for multinationals in Australia. Arguably new and proposed measures targeting multinationals give too much discretion to the ATO and are undesirable from a natural justice perspective, as they reverse the onus of proof, with companies having to prove they have not done the wrong thing. These new rules may make multinationals more reluctant to invest in Australia.
Multinationals operating in Australia should pay close attention to these developments. With the announcement of the DPT, the Australian government has already signaled that it is ready to go beyond BEPS. Given the challenge the Australian government faces in repairing its budget, and the unpopularity of many proposed spending cuts to date, the government may turn to multinationals once more as a convenient source of additional revenue.
Gene Tunny is the Principal Economist and owner of Adept Economics, an economics consultancy. He is a former Australian Treasury official.