Further to our previous alert on the exposure draft legislation for the proposed Diverted Profits Tax (DPT), today the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (Bill) was introduced into the House of Representatives. If passed, the Bill will allow the Commissioner of Taxation (Commissioner) to tax the diverted profits of certain entities at a rate of 40 per cent.
The DPT will apply to multinationals with annual global income of AUD 1 billion or more. The DPT will apply to income years commencing on or after 1 July 2017 whether or not a relevant transaction was entered into before that date.
Broadly consistent with the exposure draft legislation, under the Bill the DPT will apply to an entity (the relevant taxpayer) if:
- It would be concluded that a scheme (or any part) was carried out for a principal purpose (including where it is one of the principal purposes) of enabling a relevant taxpayer (or relevant taxpayer and other taxpayers) to:
(a) obtain a tax benefit; or
(b) both obtain a tax benefit and reduce a foreign tax liability (referred to as the principal purpose test).
- The relevant taxpayer is a member of a group with annual global income of at least AUD 1 billion (referred to as a significant global entity);
- The relevant taxpayer obtains a tax benefit in connection with a scheme involving a foreign associate;
- The increase in the foreign tax liabilities of foreign entities resulting from the scheme is less than 80 per cent of the reduction in the Australian tax liability of the relevant taxpayer (referred to as the sufficient foreign tax test); and
- The profits made as a result of the scheme by each entity that entered into or carried out the scheme, or that is otherwise connected with the scheme, does not reasonably reflect the economic substance of the entity’s activities in connection with the scheme (referred to as the sufficient economic substance test).
Several onerous measures as set out in the exposure draft legislation have been retained in this Bill. In particular, the DPT assessment and appeals process largely remains the same and encourages taxpayers to comply at an early stage in the context of rules that may ultimately be viewed as weighted in the Commissioner's favour. In this respect:
- The Commissioner’s ability to form a conclusion on the three tests listed above is not prevented by a lack of, or incomplete, information provided by the taxpayer. Further, the Commissioner is not required to actively seek further information to reach a conclusion in relation to these tests.
- Should the taxpayer challenge the DPT assessment by making an appeal to the Federal Court of Australia, the Federal Court will generally be restricted to considering evidence that was provided to the Commissioner before the end of the period of review. That is, any information or documents that the relevant taxpayer or an associate had in its custody or control at a time before, during or after the period of review, and which the Commissioner did not have in his or her custody or control during the period of review, will generally not be admissible in the proceedings.
Key changes to the proposed DPT
Four notable changes to the proposed DPT under the current Bill and Explanatory Memorandum (EM) include:
- The introduction of a specific exemption for managed investment trusts, foreign collective vehicles with a wide membership, foreign entities owned by a foreign government, complying superannuation entities and foreign pension funds. This exemption was introduced because these types of entities represent a low risk from an integrity perspective, being sovereign owned or widely held entities that carry on predominately passive activities.
- The sufficient economic substance test now considers whether or not profits made (as opposed to income derived or received) as a result of the scheme, by each relevant entity to the scheme, reasonably reflects the economic substance of that entity's activities in connection with the scheme, having regard to the functions, assets used and risks assumed by the entity. The EM confirms that all components of the profit (being the income itself and the related expenses) will need to be considered in determining whether the profits of each entity reasonably reflects the economic substance of that entity's activities.
- The EM no longer directly states that only active activities may be considered for the purpose of the sufficient economic substance test, although the examples seem to indicate that active functions are important to any analysis under this provision. Relevantly, the EM does state that arrangements where an entity reassigns activities to another entity (e.g. a back-to-back arrangement) should not be considered to be the economically significant function of the original entity.
- A change in the review period from 30 days to 60 days. The exposure draft legislation only allowed a 30 day period in which a taxpayer could appeal to the Federal Court against a DPT assessment.
Apart from the changes described above, the Bill is largely in the same form as the exposure draft legislation with some minor modifications / clarifications. For example:
- An objects clause has been inserted into the Bill to provide greater clarity on the purpose of the DPT.
- The AUD 25 million turnover test has been broadened to take into account the Australian assessable income of foreign entities (not just Australian entities) that are part of the same significant global group.
- The threshold principal purpose requirement has been amended to more closely resemble the language used in the multinational anti-avoidance law (MAAL) provisions.
- The DPT's interaction with the thin capitalisation provisions and the controlled foreign company (CFC) provisions has been clarified. In particular:
(a) If the taxpayer is subject to the thin capitalisation provisions and the DPT tax benefit includes a debt deduction, the calculation of the DPT tax benefit is modified so that the rate of interest (that would have applied had the scheme not been entered into) is applied to the actual amount of debt.
(b) In relation to the CFC provisions, any attributable income arising from the scheme which is already subject to Australian tax should not form part of the DPT tax benefit.
- For the purpose of determining whether the sufficient foreign tax test is satisfied, the Bill:
(a) Clarifies that where the tax benefit is a deductible payment, the amount of the taxpayer's Australian tax liability should be reduced by any amount withheld from that payment; and
(b) Provides for the potential introduction of tax regulations which will set out a method for working out how to calculate increases in a foreign tax liability, should practical difficulties arise in performing such calculations.
- The sufficient economic substance test now makes a specific reference to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (previously this reference was only contained within the exposure draft explanatory memorandum).
- In determining whether the sufficient economic substance test applies, the activities of an entity connected with the scheme may be disregarded if that entity's role in the scheme is "minor or ancillary".
It is also worth noting that according to the EM, the Australian Taxation Office will establish a DPT panel (similar to the existing general anti-avoidance rule panel) that will include at least one external member. Before issuing a DPT assessment, the Commissioner will generally seek the endorsement of this DPT panel.
Separate to the DPT, the Bill also:
- Introduces an increase in the administrative penalties that can be imposed on significant global entities. Specifically, from 1 July 2017:
(a) The base penalty amount for a failure to lodge tax documents on time will be multiplied by 500, increasing the maximum penalty from AUD 4,500 to AUD 450,000 (based on the current penalty rate of AUD 180, proposed to increase to AUD 210 from 1 July 2017). This effectively increases the current penalty amount that applies to large entities by a factor of 100.
(b) Significant global entities will also be subject to a penalty of up to AUD 450,000 where general purpose financial statements have not been provided to ASIC and are late, or there is a failure to lodge a statement with the Commissioner.
(c) The applicable base penalty amount for making a false or misleading statement, taking a position that is not reasonably arguable, or failing to give documents necessary to determine tax-related liabilities, is doubled.
- Updates (from 1 July 2016) Australia's transfer pricing rules to include the OECD Base Erosion and Profit Shifting (BEPS) amendments to the OECD Transfer Pricing Guidelines as formally approved by the OECD in May last year. The updates to these guidelines generally focus on issues relating to transactions involving intangibles, the contractual allocation of risks and corresponding profits where the risks and profits are not supported by activities actually carried out, and the appropriate level of returns to intra-group funding. Importantly, the amendments proposed by the Bill will not result in Australia adopting the Authorised OECD Approach for attributing profits to permanent establishments (Australia is currently guided by the OECD Commentary as it read before 22 July 2010 - i.e. Australia follows the Relevant Business Activity Approach - when attributing profits to an Australian permanent establishment).
Conclusion and next steps
It is important for multinationals with annual global income of AUD 1 billion or more to continue to monitor the progress of this Bill through the Federal Parliament and consider their positions, especially in light of any experience to date under the MAAL.
If you have a question about the Bill or would otherwise like to contact us, please do not hesitate to get in touch with a member of our team.