Are you a foreign multinational organisation in Australia?Significant new Australian international tax measures
The Australian Treasury has recently released three key pieces of draft legislation with significant consequences for foreign and Australian based multinationals in relation to:
- Thin capitalisation changes
- Denial of deductions for groups with intangibles in low tax/patent box jurisdictions
- Country By Country (CBC) public reporting
On the 16 March, draft changes to our thin-capitalisation rules were released. On the 31 March draft legislation disallowing deductions where a group has intangibles in a low tax jurisdiction were released. On the 6 April draft changes to public Country By Country disclosure rules were released; which the legislation abbreviates to CBC, rather than the abbreviation of CbC which is more commonly used by the OECD.
These are all discussed below. While they are the subject of a consultation process in which particular issues and concerns will be raised, it is expected that the Government will continue to progress in anticipation of a start date of 1 July 2023.
We recommend groups urgently review the potential impact of these measures, as they are currently proposed to impact taxpayers from 1 July 2023. For some taxpayers they may substantially increase the effective rate of tax in Australia, and lead to new public information reporting requirements. We can help you model any impact.
Thin capitalisation changes
- The draft legislation proposes significant changes to Australia’s thin capitalisation rules for non-bank / non-financial entities.
- All existing thin capitalisation tests will be replaced with new tests which are often likely to have the effect of limiting the amount of tax deductions available for interest expenses.
- Primary test will be a “fixed ratio test”, where interest deductions are limited to 30% of the entity’s tax EBITDA. This test replaces the current 60% LVR “safe harbour” debt amount which is most commonly used in the market.
- Changes are to apply from 1 July 2023, with no grandfathering / transitional concessions for existing debt arrangements, so both existing and proposed debt arrangements will need to be reviewed for compliance with the proposed new tests.
- The proposed changes were open for public consultation and review until 13 April 2023, so further changes are possible.
- The thin capitalisation rules limit the amount of tax deductions available for interest expenses. The current thin capitalisation limits (or tests) are broadly based on debt to asset ratios, or “gearing levels” of the taxpayer. Under the proposed amendments these existing tests will all be replaced with new tests that are generally based on EBITDA ratios and not linked to the gearing levels of the taxpayer.
- The thin capitalisation rules generally only apply to taxpayers with cross-border arrangements, such as foreign-controlled Australian entities or Australian entities with foreign investments. The proposed amendments do not seek to change this position.
- The amendments are proposed to apply to income years commencing on or after 1 July 2023. The draft legislation did not contain any grandfathering or transitional rules for existing arrangements. As such, any existing debt arrangements will not be exempted from the new proposed rules.
Changes to thin capitalisation tests
- 30% “tax EBITDA” limit to replace the current 60% LVR limit - Under the proposed fixed ratio test, an entity’s net debt deductions will be limited to 30% of the entity’s tax EBITDA. Broadly, “tax EBITDA” is the entity’s taxable income, adjusted for net debt deductions, tax depreciation and tax losses deducted.
- External third party debt test/limit to replace the current arm’s length debt limit - Under the proposed third party debt test, an entity’s debt deductions will be limited to those attributable to external third party debt. The external third-party debt must also satisfy certain requirements; e.g. in relation to recourse and debt fund usage requirements. This test can only be used by a taxpayer if all of its associate entities also use the same test.
- Group EBITDA ratio test to replace the current worldwide gearing test - Under the proposed group ratio test, an entity’s net debt deductions will be limited to an amount based on the relevant tax EBITDA ratio of its worldwide group.
- 15-year carry forward for deductions denied under the fixed ratio test - Any amounts denied under the fixed ratio test can be carried forward for 15 income years to be deducted in a future year, to the extent the fixed ratio test is satisfied for that year. Similar to tax losses, the entity will need to satisfy a continuity of ownership test to utilise the deductions (but no continuity of business test will be available).
- Denial of tax deductions for interest paid in respect of foreign subsidiaries - Interest expenses incurred to derive dividends that are effectively tax exempt under Australia’s participation exemption rules will no longer be tax deductible. This will be relevant where an Australian entity holds a 10% or greater interest in a foreign subsidiary.
- Transfer pricing for cross border debt - Since gearing levels will no longer be governed by the thin capitalisation rules for taxation purposes, the gearing levels of Australian entities (in addition to the interest rate for the debt) may also need to be reviewed from an arm’s length perspective under Australia’s transfer pricing rules, in respect of any cross border debt (including, particularly, shareholder or unitholder loans).
Denial of deductions for groups with intangibles in low tax/patent box jurisdictions
The draft legislation would deny deductions in Australia, for payments made by Significant Global Entities (members of groups with total global turnover of AUD1billion or more annually) on or after 1 July 2023, where the payments are even indirectly related to associates in low tax jurisdictions. The measure was originally announced in October 2022.
The draft legislation will require Australian companies of SGE groups to examine the entire global group structure, identify “intangibles” (defined more broadly than legal intellectual property) within low tax jurisdictions and consider whether payments made by Australia can be said to be indirectly “attributable to” payments elsewhere in the group for the intangibles.
- The deduction denial applies to payments, credits or liabilities for the right or permission (express or implied) to exploit an intangible asset.
- “Exploit” is defined to include use, market or distribute, supply/receive/forbear, or “do anything else in respect of”.
- “Intangible asset” is broadly defined and is said to include “access to customer databases”, “algorithms”, “leases” and “other rights over assets”.
- The deduction denial looks past the legal form of arrangements - The deduction denial applies to amounts made “in relation to” intangibles and as “as a result of the arrangement… or related arrangement” with associates. These words a given a very broad meaning - to include “legally unenforceable understandings” or “common understandings” The draft implies SGEs’ may have IP arrangements with legal forms that do not match their “substance”.
- The deduction denial (including its “low tax jurisdiction” requirement) is broader than Australia’s GAAR, MAAL and DPT - The deduction denial has no purpose requirement, unlike GAAR, MAAL and DPT. The “low tax jurisdiction” requirement is based on a 15% threshold (with statutory assumptions to work out the national federal tax of the offshore jurisdiction). As presently drafted it will affect groups with subsidiaries in Ireland and Switzerland, among other countries, for instance. The Minister can also deem a patent box regime (without sufficient economic substance) to be a “low tax jurisdiction”.
- The deduction denial can apply to both SaaS, as well as physical goods businesses - Its broad scope makes it clear that the deduction denial can apply to physical goods distributors, even if the only IP used are brand trademarks. This is despite the recognition that there are genuine supply and distribution arrangements where there is “mere marketing and selling”. A partial denial of deduction is possible as the measures are clearly said to apply to payments “to the extent to which” they fall within the provisions. This language has been given a clear “apportionment” operation where it has occurred in the Tax Act.
Country By Country (CBC) public reporting
The draft legislation in relation to CBC has a proposed commencement in relation to the 2023-24 and later years. The measures contain significant penalties for foreign companies who do not comply.
The proposal is for certain large multinationals (effectively SGEs) to be required to publish selected CBC tax information on a Australian government website, facilitated by the ATO. It applies to entities which are “CBC reporting parents”. The group must have an Australian resident member, or an Australian PE. Existing confidential CBC reporting will continue, and there is some overlap between the two reports required for Australia. The measures apply to certain companies, trusts and partnerships.
Although the measure are said to be based on EU transparency initiatives and the GRI207, it requires disclosure of information not required by those measures or even current confidential CBC reporting.
Information which must be publicly disclosed includes:
- A description of the group’s “approach to tax”
- Expenses from related party transactions
- A list (including the value of) intangible assets
- A list (including the value of ) tangible assets
- Effective tax rate
- A reconciliation between tax accrued current year and tax payable if the current rate were applied to the profit and loss.
- A description of main business activities
- Number of employees
- Revenue from unrelated parties
- Revenue from related parties
- Profit and loss before income tax
- Income tax paid (on cash basis)
- Income tax accrued (current year)
- The currency used in calculating and presenting the information.
The ATO may grant some exemptions from the measures.