Base Erosion and Profit Shifting: The Australian Perspective

Background

In July 2013, the G20 Finance Ministers, including Australia, fully endorsed the base erosion and profit shifting (BEPS) Action Plan. As a result of the Action Plan, the Australian government encouraged a new commitment to focus resources on investigating international business structures to ensure companies pay tax in the country where the profit is earned.

The G20 also called on member countries to examine how their domestic laws contribute to BEPS and to ensure that international and domestic tax rules do not allow or encourage multinational enterprises to reduce overall taxes paid by artificially shifting profits to low-tax jurisdictions.

In late July 2013, the Australian Treasury released a scoping paper titled “Risk to the Sustainability of Australia’s Corporate Tax Base” (“Paper”).  This Paper concluded that:

The extent to which base erosion and profit shifting is currently affecting Australia’s corporate tax base is unclear;

It is clear that there are real and identifiable risks facing Australia’s corporate tax base;

While some action can be taken unilaterally, the key focus should be working multilaterally with international organizations to modernize international tax rules.

The Paper made the following recommendations:

To endorse the Organization for Economic Co-operation and Developments (OECD) Action Plan to address the key drivers of BEPS;

To release of additional information on the state of the corporate tax system and international dealings;

To expand and undertake a more timely exchange of information with other revenue authorities; and

To review of Australia’s bilateral tax treaties at least every 10 years to ensure they continue to be in the national interest.

Legislative reforms

As part of the BEPS measures, the Australian government has already introduced the following legislative changes:

Changes to Australian thin capitalization rules which reduce the “safe harbor” debt limit from 3:1 to 1.5:1 on a debt:equity basis (for a non-financial institutions), with the aim of addressing profit shifting through the artificial loading of debt into Australia.  These rules have passed through Parliament and are currently waiting Royal Assent.  Once they receive Royal Assent they will apply to income years commencing on or after July 1, 2014, and will materially impact on the availability of interest and other debt deductions available in Australia to a multinationals Australian operations.

New transfer pricing rules which apply from July 1, 2013 and are broader in scope than the previous rules.  The new rules require a detailed consideration of arm’s length pricing and conditions and also give the Australian Tax Office (ATO) reconstructive powers on transactions.  However, the rules do not extend to rules on the attribution of profits to permanent establishments, and it is unclear if and when Australia will adopt the OECD approach in respect of PE profit attribution.

New measures have been introduced in Australia that are intended to improve the transparency of Australia’s corporate tax system.  Under these rules, the Commissioner of Taxation is required to publish certain tax information of large corporate taxpayers (on a named basis), including the total income as reported in the entity’s tax return.

Other Projects Underway

The Australian government continues to be an active participant in the current global debate on BEPS.  At the September 2014 G20 Finance Ministers’ meeting in Cairns Australia, it reaffirmed its commitment to address the challenges raised by BEPS.

More recently, as a result of further Australian government encouragement, there has been a further commitment on the part of the ATO to focus resources on investigating international business structures to ensure companies pay tax in the country where the profit is earned. Some of the specific measures and projects underway include:

Addressing tax challenges of the digital economy

In an E-Commerce project, the ATO has identified business structures that exacerbated the BEPS risk, generating income from highly mobile and valuable intellectual property. Five tax agencies came together to investigate global tax planning of e-commerce multinational enterprises (MNEs), giving them a better understanding of such companies and enabling them to examine the MNE’s compliance with existing law.

The ATO’s International Structuring and Profit Shifting program (ISAPS) focuses on companies that have significant cross-border-related party arrangements or that have undertaken international restructures. Results from the first year of reviews provide evidence to support consideration of whether any law reform would be needed.

The ATO is reviewing its advance pricing arrangement and Mutual Agreement Procedure programs, particularly to have in place early engagement procedures.

Hybrid mismatch arrangements

While Australia does not have specific anti-hybrid mismatch rules, any potential action in this area will depend on risk levels from hybrid mismatches and taking into consideration work already underway in relation to existing anti-avoidance measures, such as changes to the thin capitalization rules.

Australia does have rules (such as the debt/equity rules and the Taxation of Financial Arrangement (TOFA) rules) that can operate to characterize certain financial arrangements based on their economic substance rather than their legal form.  There is potential for a mismatch in characterization to occur where such financial arrangements are being issued and held cross-border.

Australia’s Board of Tax (an advisory body to the government on taxation matters) has been requested to undertake a review of Australia’s debt/equity rules with the view of advising the government on whether these rules can be improved to address any inconsistencies between Australia’s tax system and that of other jurisdictions in respect of debt and equity classifications for tax purposes, with the aim of minimizing arbitrage opportunities.  The Board of Tax is to report to the government by March 2015 on this issue.

Prevention of treaty abuse

Australia has a strong interest in developing a Principal Purpose Test in its bilateral tax treaties due to the difficulties in applying Pt IVA anti-avoidance measures to complex offshore arrangements.  The objective of having such a test will be to deal with instances of intended treaty abuse.

Transfer pricing documentation

The ATO is reviewing the impact of the OECD’s recommended country-by-country reporting documentation on its administrative and compliance products.  This documentation will require a master file of standardized information for all members of the multinational group and then a local file containing material transactions referable to the local taxpayer.  It is also considering the inclusion of a materiality threshold, i.e. to have a minimum global turnover before being obliged to report.

Broader transparency issues

Other global transparency measures such as the automatic exchange of information and implementation of the Common Reporting Standard, are supported by the ATO’s compliance approaches, e.g., the International Dealings Schedule, reportable tax positions, reporting of large company financials, and Project DO IT.

Compliance Activities of the ATO

The ATO’s 2013-14 Compliance Program has a heavy focus on BEPS, with profit shifting being identified as a significant tax compliance risk for medium to large businesses.

The ATO has established a new compliance project team called ‘International Structuring and Profit Shifting’ which will review profit shifting risks and undertake risk review and audits in this area, with the following focus areas:

migration of intangibles (IP) offshore

creation of offshore hubs

debt push down/excessive interest arrangement in Australia

tax arbitrage via hybrid entities/instruments

base erosion via related-party leveraging

treaty abuse

transfer pricing outcomes that are inconsistent with arm’s length outcomes including so called “tax effective supply chains”.

Conclusion

Global businesses with a presence in Australia need to be aware of the issues associated with BEPS and should be undertaking a risk review of their cross-border activities.  The ATO is conducting risk reviews in this area and currently transfer pricing reviews and audits are on the increase in Australia.

Going forward taxpayers will need to monitor legislative changes in this area and new approaches being adopted by the ATO in compliance activities and documentation requirements.