This morning many commentators are likely to be suggesting that last night's budget was short on excitement. However, in reality it has been many years since there has been so many significant tax measures. These include two measures aimed at multinationals focused on in this Alert – an expansion of Part IVA and expanding the operation of GST.
The multinational anti-avoidance law
Last night, the Government released draft legislation for the tax integrity multinational anti-avoidance law. In a nutshell, the proposed new law is an expansion of Part IVA so that it can more effectively deal with the artificial avoidance of a taxable presence in Australia (ie. a permanent establishment). Although the new law borrows some concepts from the UK's diverted profits tax, it is significantly more limited in scope.
The draft legislation targets schemes where:
- a non-resident entity derives income from supplying goods or services to Australian customers with an entity in Australia supporting that supply; and
- the non-resident avoids the attribution of income from that supply to a permanent establishment in Australia.
The new law is intended to apply where a person carried out the scheme for a principal purpose or one of the principal purposes of enabling a taxpayer (ie. the non-resident) to obtain a tax benefit.
An expansion of Part IVA
The new law is being inserted into the existing anti-avoidance provisions in Part IVA, which generally rely on a "dominant purpose" test. In contrast, the proposed section 177DA relies on "a principal purpose" or "more than one principal purpose" test. In particular, it is not necessary that the scheme was entered into for a dominant purpose of a taxpayer obtaining a tax benefit – it is sufficient if it was merely one of the purposes.
The broadening of the "purpose test" is intentional to address circumstances where a multinational entity may seek to argue that the global arrangement is entered into for the purpose of avoiding tax in another country. It is also consistent with the UK's diverted profits tax, which refers to "one of the main purposes" being to avoid a charge to corporate tax.
It is interesting to note that if the new law is passed, Part IVA will have three different "purpose tests":
- a dominant purpose test in section 177D;
- a principal purpose test in section 177DA; and
- a purpose (but not an incidental purpose) test in section 177EA.
Limitations on the scope of the new law
The new rules don't attempt to anticipate the outcome of the OECD consideration of digital economy issues by rethinking the concept of the permanent establishment. The current notion of a permanent establishment is respected. Rather, these rules target the perceived artificial avoidance of an Australian permanent establishment by certain non-resident taxpayers.
There are a number of gateways that taxpayers will need to pass through before the rules apply.
The new rules will not apply where a non-resident operates completely from outside of Australia and some of the activities associated with the supply are not undertaken by an Australian resident who is associated or commercially dependent on the non-resident. So the rules will clearly not apply to companies that only deal with Australian customers over the internet and do not have any support functions in Australia. One sincerely hopes that concern over the new rules will not result in foreign multinationals laying off their Australian employees and servicing Australian customers from offshore or on a fly in fly out basis.
As the new law is concerned with the avoidance of a permanent establishment, it will not apply to supplies to related parties in Australia.
Furthermore, the additional requirements for the application of the new law (ie. the annual global group revenue of $1 billion and a connection with a no or low tax corporate tax jurisdiction) mean that section 177DA will not apply in all circumstances where there is an avoidance of a taxable presence in Australia. However, that said, according to Forbes magazine in 2013, there were over 1922 public traded companies in the world with sales of US$1 billion or more. There are a lot of companies that may still be potentially caught by the new law – it's not limited to the household names that have made the press headlines.
A further requirement for the new law to apply is that the non-resident or another entity within the group which indirectly contributes to the supply must be located in a no or low tax jurisdiction, provided that there is no substantial economic activity relating to the supply conducted in the no or low tax jurisdiction. The draft explanatory memorandum asserts that the rules only target multinationals that ultimately return a "substantial proportion" of the profits from Australian sales to a low or no tax jurisdiction. The trouble is the legislation doesn't say that – it merely requires that there be a connection to the no or low tax jurisdiction.
As you address the various legislative gateways in the new rules you are confronted by a series of vague and untested concepts. These build on each other, so by the end of the interpretative process taxpayers will inevitably face considerable uncertainty as to whether the law applies in their particular circumstances.
- Is it "reasonable to conclude" the scheme is designed to avoid deriving income from a permanent establishment?
- Has the "principal purpose" test (of obtaining a tax benefit) been satisfied?
- Is the non-resident "connected" with a no or "low corporate tax jurisdiction"? (The pre-release materials talked in terms of tax havens, but is that what the term means? How low is low?)
- The rules may apply where the activity in the no or low tax jurisdiction is "indirectly" related to the Australian supply ( that may not be obvious in many cases).
- If "substantial economic activity" is conducted in the no or low tax jurisdiction then the taxpayer is home safe, but again there is no real guidance on the meaning of this expression.
The explanatory memorandum suggests that if the provisions are activated then the Commissioner would be empowered to make a determination effectively attributing the "income from the supplies to Australian residents to an Australian permanent establishment".
However this misconceives the attribution process – which is one of profit (not income or revenue) attribution. That is in itself a controversial exercise and the subject of much debate among OECD countries. It may be that there is in fact comparatively little value which would be added by the notional Australian permanent establishment, as all the significant value add may be referable to offshore activities and intellectual property.
Australia goes it alone
One of the real concerns that will need to be considered is that by taking unilateral action Australia will be out of step with other OECD countries. One of the fundamental motivations behind the OECD's BEPS (base erosion and profit shifting) initiative was to deliver a co-ordinated, considered and multilateral solution to a series of perceived global tax issues. By going it alone there is a risk that inbound investors will be subjected to a double tax burden.
For example if Australia taxes a deemed permanent establishment profit under the new rules it may be that the non-resident's home jurisdiction will not grant a credit as it may not consider that the taxed income was (from its perspective) foreign sourced. It would certainly be unlikely to credit the 100% penalty which has been proposed.
The new rules are expressed to apply for tax benefits obtained from 1 January 2016. Submissions on the draft materials are due by 9 June.
Often budget nights come and go with very little being said about GST. However, at least this time there has been a significant change – even if it had been announced the day before. In addition, the Government has announced that it will not now be proceeding with the previously announced proposal for "reverse charging" the GST on supplies of going concerns.
Inbound intangible consumer supplies
The GST will be amended to allow for the imposition of GST on "inbound intangible consumer supplies". The new measures are proposed to apply to supplies made on or after 1 July 2017. Taxpayers affected by the new rules have until 7 July 2015 to make submissions to Treasury.
In an effort to avoid disputes regarding who is in fact making the "supply", the new provision provide that GST will be generally be recovered from the "operator" of the "electronic distribution service". This is done by deeming the operator to be:
- the entity making the supply;
- making that supply for consideration; and
- doing so in the course or furtherance of the enterprise being carried on by the operator.
An "electronic distribution service" is defined to be the electronic distribution platform through which the service is made available – be it a "website, internet portal, gateway, store or marketplace".
Both the Exposure Draft and the draft Explanatory Memorandum presuppose that the identity of the operator will be obvious – there is no definition and seemingly little precision around this concept. Given the critical importance of this term, perhaps further focus on this point during the consultation phase would be useful.
The concept of "inbound intangible consumer supplies" is surprisingly broad – encompassing any supply (other than of goods or real property) to an "Australian consumer" unless the supply is "connected with indirect tax zone" (for present purposes the "indirect tax zone" should be taken to mean Australia). This would take the operation of these provisions far broader than originally thought. Certainly, the definition will extend to apps, software, music downloads and video streaming services. But it will also extend to other services offered through a website or portal – navigation, valuation, insurance, legal advice – any service delivered by "electronic communication".
The ability to recover the GST payable from the "operator" is an important practical matter – many purchasers of apps would be entirely unaware of the identity of the app's developer. The "operator" of the electronic distribution service will only be able to shift liability back to the entity that is actually making the supply where:
- an invoice is issued which identifies the actual supplier as the supplier of the supply;
- the actual supplier is identified "in the contractual arrangements" as being the person responsible for the payment of the GST on the supply; and
- the operator of the electronic distribution service does not "authorise" the charge to the recipient for the supply, does not authorise the delivery of the supply and does not set the terms and conditions under which the supply is made.
Finally, the definition of "Australian consumer" is limited to entities that are Australian residents. Interestingly, as a result, "consumers" are not limited to natural persons. A company or even a partnership or a trust can be an "Australian consumer" where it is a resident for tax purposes and is not registered or required to be registered. As such, the imposition of GST under these new measures cannot be avoided simply by signing up for a video streaming service in the name of a passive company.
Reverse charge reversal
The operation of the current GST-free treatment for going concerns has been the subject of continued controversy. The requirement for the supply of "all things" necessary for the continued operation of the enterprise produces complexity and a degree of artificiality. It was hoped that these tests could be relaxed and a "reverse charge" mechanism would be introduced to require the recipient of a going concern to account for GST.
However, difficult interactions with stamp duty, the removal of the "Division 135 problem" following the High Court's decision in MBI and perhaps a reluctance to broaden the scope of the provisions has finally seen the withdrawal of this proposal as part of this year's Budget measures.
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.