Base Erosion and Profit Shifting – Australia's role in a global project
"Base Erosion and Profit Shifting" (BEPS) has become a shorthand term of many developed economies to describe a symptom of declining corporate tax revenues around the world.
Causes continue to be the subject of speculation, including theories at the more extreme end regarding aggressive tax planning by multinational corporate groups seeking to take advantage of gaps in international tax rules by a variety of means, including transfer pricing, tax havens, hybrid entities and thin capitalisation.
Following an OECD report in February 2013 which highlighted the problem, the OECD recently issued an Action Plan on BEPS which sets the stage for further international development. The Australian Government itself released a "scoping paper" in July 2013 which set out the Government's intention to take action. In addition, the Australian Treasurer and the UK Chancellor of the Exchequer issued a joint media release in August expressing an agreement to "combat tax avoidance and evasion".
It is a safe prediction that BEPS will be a priority topic when Australia hosts the G20 next year.
Motivations for a global project on BEPS
Reviews into the so-called practice of international tax planning by multinationals are not a new phenomenon. OECD member countries have grappled with the appropriate allocation and exercise of taxing powers between nations, including how to address the use of tax havens and how to enforce transfer pricing for a long time. Many countries, including Australia, already have detailed domestic laws and processes to address the concerns (actual and perceived) arising from international tax planning activities. Australia recently made a range of amendments to its own transfer pricing laws.
But the Australian Government and the OECD have embarked upon a renewed push to resolve what they believe to be a growing problem. This may be influenced by further declines in revenues at a time when governments can least afford them, or a general acceptance that despite the existence of domestic anti-avoidance rules in countries like Australia, the problem can no longer be addressed by one country acting alone. In the background, certain economists have for some time predicted a gradual reduction in the global corporate tax base. This was a feature of the 2009 report Australia's future tax system (the Henry Review).
The Australian BEPS scoping paper covers a lot of ground and sets out a range of statistics to reenforce the existence of the problem and a variety of explanations for it. It is suggested that BEPS is increasing as a result of globalisation, both in terms of increased mobility of investment, flexibility in location of intellectual property and intangibles and also internet-based business. These factors are perceived to create a fertile environment for multinationals to exploit inconsistencies in international tax rules and tax rates by, for example, realising value from sales in low-tax country A even though the sales are generated from customers in higher-tax country B. In terms of recommendations, the paper proposes greater publication of taxation statistics involving international dealings, ten-year reviews of all bilateral tax treaties, expanded tax information exchange arrangements and an endorsement of the OECD's Action Plan. The "scoping paper" identifies a problem and sets a path for Australia (with other countries) to proceed with intent in search of the solution.
Features of the Action Plan
The OECD Action Plan contains a set of fifteen "actions". The OECD BEPS project is still in its early stages, and this is evident from some of the broad objectives which appear to be directed more at solidarity and identifying the cause of the perceived problem than recommending particular solutions at this time.
The path ahead
There is some evidence that OECD Governments believe that the first task in achieving this significant project is to encourage negative perceptions about relevant corporate behaviours, by demonising (rightly or wrongly) multinational groups who engage in activities that Governments and others believe should be perceived as highly questionable notwithstanding that they may conform with current law.
In late 2012, Assistant Treasurer David Bradbury shone the spotlight on Google, citing a low effective tax rate in Australia on certain transactions. In the UK, widely publicised campaigns against a number of taxpayers and appearances before the UK Public Accounts Committee by various multinational corporations with significant value in intangibles led to statements by Starbucks suggesting that it would pay millions of pounds in taxes voluntarily in response to public pressure.
But there is a limit to how much assistance may be obtained by encouraging public support at home. Legislating to prevent an entity (which may not be locally resident) from arranging its commercial affairs in a foreign jurisdiction may require fundamental changes to accepted treaty rules about source of income and residence. This not only requires public support, but buy-in from a wide range of jurisdictions including, quite possibly, international low-tax and notax jurisdictions that are alleged to enable the corporate behaviours underlying BEPS.
A summary of the actions is as follows.
|1||Address the tax challenges of the digital economy|
|2||Neutralise the effects of hybrid mismatch arrangements|
|3||Strengthen controlled foreign company rules|
|4||Limit base erosion via interest deductions and other financial payments|
|5||Counter harmful practices more effectively, taking into account transparency and substance|
|6||Prevent treaty abuse|
|7||Prevent artificial avoidance of permanent establishment status|
|8||Address transfer pricing arrangements for intangibles|
|9||Address transfer pricing arrangements related to risks and capital|
|10||Identify and address other high risk transfer pricing arrangements|
|11||Establish methods to collect and analyse data on BEPS|
|12||Increased disclosure of aggressive tax planning arrangements|
|13||Re-examine transfer pricing documentation|
|14||Make dispute resolution mechanisms more effective|
|15||Develop a multilateral instrument|
Each of these actions will be accompanied by further research and reporting of recommendations between September 2014 and December 2015.
One thing for certain is that Australia has marked itself as intent on playing a leading role in the campaign to fight BEPS, and its role in hosting the G20 is likely to provide the perfect platform.
Employee share scheme concessions for start-up companies on the government's agenda
The Government has released a discussion paper on proposed changes to employee share scheme arrangements for start-up companies
This proposal follows from a range of reports recommending further work in relation to share or option remuneration for employees of new companies, including the governmental report entitled Advancing Australia as a Digital Economy: An Update to the National Digital Economy Strategy.
The discussion paper raises several options for reform, including:
- further deferral concessions;
- lower taxation rates;
- greater discounts on taxation; and
- valuation concessions.
The current tax system and difficulties for start-ups
Currently, taxation on employee share schemes is borne by employees, with some limited reporting requirements on employers. Unless a deferral concession applies, employees will be taxed upfront when they receive shares or rights under a scheme on the value of the shares or rights at that time. There is currently a $1000 discount on assessable income for certain widely available upfront-taxed schemes.
The deferral concession only applies for particular low-value salary sacrifice plans and also for plans under which the employee must satisfy performance or employment conditions which mean that the employee is at risk of losing their shares or options. In that case, the employee will be taxed at a deferred taxing point (usually when the performance or employment condition is satisfied and there are no restrictions on sale of the shares or options).
It is common for start-up companies to provide a component of an employee's remuneration in shares or options for retention and incentive purposes. One difficulty in relation to the above tax regime for unlisted start-up companies is that there may be no market for the sale of the shares until an IPO or other liquidity event occurs in relation to the shares or options. This presents a problem not only in terms of the employee's ability to trade their taxable assets, but also the valuation of shares and options for tax purposes in the absence of a market for those assets.
Defining a 'start-up'
The discussion paper identifies that this proposal is a targeted regime for new and entrepreneurial businesses, and one challenge will be in defining the eligible recipients of the concession. The paper analyses relevant characteristics of a 'start-up', including in relation to similar concessions in the UK and Singapore, and proposes the following definition:
- 15 or fewer employees;
- aggregate turnover of less than $5 million and not a subsidiary of another corporation;
- less than 5 (or possibly 7) years old;
- a test directed at entrepreneurial activity (ie must be providing new products, processes or services based on development and commercialisation of IP); and
- an "in Australia" test (ie majority of employees and assets must be in Australia).
Proposals for reform
The paper proposes the following alternatives which are aimed at granting concessions to employees of start-ups either in relation to the timing of taxation or the amount of tax payable:
- a deferral of taxation until the year of sale of shares or exercise of options;
- a deferral of the time at which tax is payable rather than the time at whichthe tax liability is valued (which may continue to be on an upfront basis);
- a lower tax rate (such as 15%); and
- an increased upfront discount to assessable income (such as $5,000).
The options would continue to tax gains on employee schemes and options as income subject to marginal rates of taxation.
The paper also reiterates previous discussion regarding the difficulties in valuation for start-ups in an illiquid market for the underlying shares. The paper proposes some alternative methodologies that may help to reduce or eliminate valuation costs in such circumstances, such as the endorsement of a "net asset backing" valuation (ie using the company's balance sheet to value the underlying shares).
As a general observation, one might be tempted to favour the government's first alternative above, being an extended deferral of taxation to the time of exercise or sale of options or shares, being a time at which the shares can more easily be valued. Not only does this extended deferral provide a significant concession for cash-constrained start-up companies but also goes some way to solving the problem of valuation in many cases. The government has highlighted that one of its main concerns with this alternative is that it may be open for abuse if companies offer a sizeable proportion of remuneration in the form of shares or options or attempt to inappropriately characterise themselves as a 'start-up' to obtain the concession. However, the government appears to acknowledge that this latter concern may be addressed in advance by "tightly defining" a start-up company.
As an administrative measure, the paper also raises the possibility of introducing or expanding the use of governmentendorsed "standardised ESS documentation" to reduce compliance and legal costs for start-ups.
Exploration expenditure under the microscope
On 14 May 2013, then Treasurer Wayne Swan foreshadowed reform to the immediate deduction entitlement for exploration expenditure. This announcement came shortly after the Administrative Appeals Tribunal (AAT) considered what constitutes "exploration" for petroleum resource rent tax purposes in the ZZGN case. Both developments are of interest to those involved in the energy and resources sector.
Section 40-80 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) provides that a taxpayer is entitled to an immediate deduction for the costs of depreciating assets first used in exploration.
Treasury's proposed amendments
Treasury is of the view that s 40-80 of ITAA 1997, as currently drafted, allows exploration and development expenditure to be conflated, and claimed as an immediate deduction. As evidence of taxpayer "abuse" in this area, Treasury points to:
- the growing number of claims under s 40-80; and
- a practice whereby mining rights and information are sold at a high price, reflecting the value of the minerals already discovered, to a purchaser who then undertakes nominal confirmatory exploration and claims an immediate deduction for the cost of the entire transaction on the basis of it being exploration expenditure.
As part of a broader package of reforms designed to prevent corporate tax base erosion, Treasury released a proposal paper entitled "Targeting the immediate deduction for mining rights and information first used for exploration". Submissions on the paper closed on 12 July 2013.
Treasury is proposing that the immediate deduction for expenditure on mining rights and information be confined to circumstances where:
- the right is acquired from a government issuing authority;
- the right is acquired as a farmee in a 'farm-in, farm-out' arrangement;
- the information is acquired from a government authority; or
- the information is created through exploration or prospecting.
Expenditure on mining rights and information will otherwise be deductible over 15 years or the effective life of the rights or information, whichever is shorter.
If the proposed changes are legislated, then one issue for taxpayers will be how they apportion values between tangible and intangible assets acquired in the one transaction. Simplifying the tax treatment of expenditure on intangible assets was the rationale originally for including mining rights and information in s 40-80.
In addition to the reforms above, the Treasury paper indicates that the ATO is reconsidering its interpretation of "exploration" as used in tax law. It would seem that the ATO's reconsideration of the "exploration" concept has been prompted by the AAT decision in ZZGN v Commissioner of Taxation  AATA 351 (ZZGN).
ZZGN concerned s 37 of the Petroleum Resource Rent Tax Assessment Act 1987 (Cth) (PRRTAA), which allows taxpayers a deduction for payments made "in or in connection with exploration for petroleum".
"Exploration" is not defined in the PRRTAA. In considering the term, the AAT held that there was nothing in the various other concessions in tax law, case law or in the PRRTAA's extrinsic materials that justified a departure from the ordinary meaning of the term "exploration", albeit a meaning understood in the context of petroleum legislation.
In fleshing out the ordinary meaning of "exploration", the AAT cited with approval the 1996 Report of the Australian Bureau of Agricultural and Resource Economics (ABARE Report); accepting that all survey and drilling activities referred to in the ABARE Report, and the associated scientific and technical analysis, would fall within the concept.
The AAT will treat surveying a prospective field and drilling to appraise the size of a field as exploration under the PRRTAA. Feasibility studies and preparatory work, on the other hand, are of a "distinctly different nature" as they occur only after a discovery has been made.
ZZGN suggests that there is a temporal aspect to "exploration". Despite the AAT dismissing the "exploration phase" and "production phase" dichotomy in the ABARE Report, it seems, according to the AAT, that generally exploration occurs only up until the point of discovery. The problem however, is in stating precisely when a discovery is made. Between first identification of the resource and the commissioning of feasibility studies lies a range of activity that, on the AAT definition, may or may not constitute exploration. When, for instance, does appraising the size and quality of a field constitute exploration and when does it constitute a feasibility study for future development? In that regard, clearly exploration and feasibility studies are not unrelated concepts.
The difficulty here is further complicated by the AAT's suggestion that expenditure on feasibility studies, though not "exploration" ordinarily, could be deductible under s 37 where a "reasonably direct connection" exists between the studies and exploration.
At a time when Australia is experiencing a significant reduction in the levels of exploration activity by its miners, Treasury's proposed reform to s 40-80 of the ITAA 1997 and the AAT's failure to adopt a bright line test for determining what constitutes "exploration" activity have:
- reduced the available taxation incentives for miners in conducting exploration activity; and
- increased the uncertainty, and consequently the compliance costs, associated with the already difficult task of characterising expenditure in the energy and resources sector.
These developments can only add to the disincentives for miners in undertaking new mining exploration activity in Australia.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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