Government priorities for further counteraction of perceived multinational tax avoidance

Documents recently issued by the Parliamentary Budget Office (PBO) and Treasury have shed light on potential design features of the Government’s Plan to Ensure Multinationals Pay Their Fair Share of Tax (the “Plan”), particularly in relation to the ‘tax havens integrity’ measure proposed to apply to certain offshore royalty payments.

While subject to public consultation, the potential design features reveal:

(a) There may be significant and unexpected implications for a large body of taxpayers with international connections, and

(b) Extant uncertainty regarding the practical operation of some of the proposed measures.

These developments should therefore be closely monitored by multinationals with operations in Australia which are either leveraged and/or paying royalties to foreign related entities.

Background

Since RSM Australia’s article in May 2022 regarding the potential tax implications of the 2022 Federal election result, two key documents have been released:

•    PBO’s 2022 Election Commitments Report (ECR) on 14 July 2022; and
•    Treasury’s consultation paper on the Plan, entitled ‘Government election commitments: Multinational tax integrity and enhanced tax transparency’ (the “Consultation Paper”) on 5 August 2022.

As noted above, The ECR and Consultation Paper are insightful in two ways.

Firstly, they both arguably describe the Plan quite differently from what was apparent or could be inferred from releases by the Australian Labor Party (ALP) immediately prior to the 2022 Federal election, as well as prior to the 2019 Federal election (particularly in relation to the proposed ‘tax havens integrity’ measure).

Secondly, they arguably fail to clarify the practical operation of certain measures such as component 6, entitled ‘mandatory reporting of tax haven exposure to shareholders’.

ECR

The ECR quantifies components 2 and 3 of the Plan (i.e., ‘limiting debt-related deductions by multinationals’ and ‘tax havens integrity’, respectively), which are, together, forecast to result in additional tax receipts of $1.896b over the forward estimates period to 30 June 2026¹.

While the costing assumptions for component 2 are consistent with how the measure was described in releases by the ALP prior to forming Government, the costing assumptions for component 3 arguably depart from what was widely understood of the proposed measure.  

Specifically, whereas the Government previously described the measure as directed toward egregious activity, i.e., the ‘abuse’ of double tax treaties involving ‘tax havens’, the ECR:

•    In contradistinction to the Government’s 2019 release (which referred to ‘harmful’ regimes, i.e., consistent with OECD BEPS Action 5), refers to royalties distributed to intellectual property (IP) tax-preferential regimes and cites specific countries with such regimes in place;
•    Does not reference any ‘motive’ or ‘purpose’ requirement (e.g., of tax avoidance);
•    Assumes that countries with a corporate tax rate of below 24% would, consistent with the ‘sufficient foreign tax test’ contained in section 177L of the Income Tax Assessment Act 1936 (ITAA 1936), be within the scope of the measure.

The foregoing suggests a potentially significant expansion of the ‘tax havens integrity’ measure, particularly when compared to the Government’s 2019 release.

Consultation Paper

The Consultation Paper describes the potential features of the Plan’s components and invites submissions thereon. Key observations in respect of how each component is described in the Consultation Paper are set out below².

Reforming Australia’s Thin Capitalisation Rules

The proposed reforms to Australia’s thin capitalisation rules are described in a manner consistent with the OECD’s BEPS Action 4 recommendations and will bring Australia’s rules in line with other G20 nations such as Germany, the United Kingdom, and the United States (i.e., a fixed ratio rule at 30% of EBITDA).

Further positive observations  on this aspect of the Consultation Paper include:

•    Potential inclusion, consistent with OECD recommendations, of an earnings-based group ratio rule entitling highly-leveraged groups to higher debt deduction by providing an uplift on net third-party debt deductions;
•    Again, consistent with OECD recommendations, potential concessionary rules for projects that provide net public benefits or are considered nationally significant (i.e., similar to the Public Benefit Project Exclusion in the United Kingdom; and
•    Exclusion of financial entities and authorised deposit-taking institutions from the fixed ratio rule in recognition of such entities being net lenders and subject to regulatory capital rules.

A potentially concerning observation relates to Treasury’s adverse comments regarding the arm’s length debt test and taxpayers potentially resorting to it as a behavioural response to the fixed ratio rule.

While it is acknowledged that the arm’s length debt test can be difficult to apply, such comments disregard its significant utility to many taxpayers, and its removal would contravene the following pre-election commitment by the Government:

“We will ensure we are targeting tax minimisation and firms may be able to make further deductions if they can substantiate those under the arm’s length debt test or worldwide gearing ratio test.“

Denying Income Tax Deductions To Multinationals For Cross-Border Royalty Payments

The Consultation Paper invites submissions on particular aspects of the ‘tax havens integrity’ rule, including the population of taxpayers that should be within scope (i.e., whether the measure should transcend Significant Global Entities (SGE) and related party dealings), whether the measure should extend to address embedded royalties, and how ‘insufficient tax’ should be defined. The Consultation Paper also summarises comparable measures in place in other jurisdictions.

While Treasury’s solicitation of submissions is welcome, relevant observations include:

•    Not inconsistent with the ECR, the absence of any request for submissions on the potential inclusion of a ‘motive’ or ‘purpose’ test;
•    Potential conflation of issues relating to ‘embedded royalties’. Embedded royalties were referenced in neither the Government’s most recent release nor the ECR, but are subject to significant consideration in the Consultation Paper;
•    The cited overseas measures are not necessarily comparable. For example, the United States’ Base Erosion Anti-Abuse Tax (BEAT) is an alternative minimum tax that significantly transcends royalty payments; and
•    Not all the potential bases for defining ‘insufficient tax’ or a ‘low or no tax jurisdiction’ are intuitive, which is compounded by the absence of any ‘motive’ or ‘purpose test’. For example, the interaction with Pillar Two is unclear, and potential focus on all IP tax-preferential regimes is arguably inconsistent with OECD BEPS Action 4

These observations evince a quixotic character and could render this proposed measure impracticable.

Public Reporting of CBC Information

This component of the Plan is described consistently with the Government’s prior releases. Although a potential compliance burden for certain taxpayers, the invitation for submissions on potentially leveraging relevant standards published by the European Union and Global Reporting Initiative is welcome and could result in public information that is more meaningful to users and, therefore, more transparent. The (novel) proposal to legislate the currently voluntary Tax Transparency Code also warrants consideration, given the relatively low uptake to date.

Establishment of A Public Registry Of Ultimate Beneficial Ownership Information

This proposed measure is not addressed in the Consultation Paper, with Treasury noting:  ‘Further details on the beneficial ownership register will be announced in due course’.

Mandatory Reporting of ‘Tax Haven Exposure’

This proposed measure is described in the Consultation Paper somewhat more broadly than the ECR and prior releases by the Government, with its potential ambit extended to ‘other forms of high-risk tax arrangements’ such as self-assessed ratings under Practical Compliance Guidelines.

Observations in respect of this measure, and its potential extension include a lack of clarity with respect to:

•    How the measure will interact with Pillar Two – e.g., why doing business in a jurisdiction with a tax rate below 15% is considered a ‘material tax risk’ given there are mechanisms to ensure the global minimum rate of tax is ultimately borne;
•    The purpose and intended effect of the proposed extension of the measure, given AASB Interpretation 23 Uncertainty over Income Tax Treatments, which supplements the Reportable Tax Positions schedule, and requires the quantification and public disclosure/recognition of uncertain tax positions (i.e., where it is probable that a ‘taxation authority’ will not accept a tax position).

Tax Transparency Requirements for Australian Government Tenderers

The description of this proposed measure is unchanged from prior releases by the Government and the ECR. Questions remain regarding the intended purpose and practical operation of this measure, given the lack of meaningful information afforded by a particular legal entity’s country of domicile for tax purposes, and the potential for circumvention. For example, most multinationals have subsidiaries in various countries for both commercial and non-commercial purposes.

Conclusion

Taxpayers should be aware that the ECR and Consultation Paper indicate the proposed measures may apply in a manner, and to classes of taxpayers, not originally envisaged when the Government announced the Plan. Further clarity regarding the practical operation of many of the proposed measures is also required.

If you need any assistance or have further questions, please contact your local RSM office or email [email protected].