Australian diverted profits tax legislation introduced

by Julian Feiner, Dentons, London

First came the UK’s diverted profits tax and now an Australian diverted profits tax is imminent. The draft law was introduced into Parliament February 9 and is expected to take effect from July 1.

Its aim is similar to the UK’s section 80 provision, targeting arrangements with insufficient economic substance, but with distinctive Australian rules, a wider playing field, and harder hitting penalties.

The government’s intentions are stated boldly. In a media release, the Treasurer hails the Australian diverted profits tax as a “powerful new tool” that will “reinforce Australia’s position as having some of the toughest laws in the world to combat multinational tax avoidance.”

The law is intended to complement the existing armoury of anti-avoidance measures at the Australian Commissioner’s disposal, including the multinational anti-avoidance law, which applies in respect of avoided permanent establishments.

The draft law is stated broadly. It applies a 40% tax rate to a tax benefit obtained by an Australian entity in a scheme carried out with a foreign associate for a principal purpose of obtaining the tax benefit.

This is subject to relevant thresholds and exceptions. In particular, the rules only apply to multinational groups with more than A$1 billion global revenue and do not apply if, for example:

• The sufficient economic substance test is satisfied – i.e., the profit earned “reasonably reflects the economic substance of the entity’s activities in connection with the scheme;” or

• The sufficient foreign tax test is satisfied – i.e., the foreign tax liabilities from the scheme are at least 80% of the corresponding reduction in the Australian tax liability; or

•  The Australian turnover of the group, together with the amount of the relevant tax benefit, does not exceed A$25 million (unlike the UK, which has no threshold but exempts SMEs).

On reading the explanatory memorandum, however, it appears that “the [diverted profits tax] will be applied only in very limited circumstances” and only after giving consideration to the operation of other provisions. The forecast revenue from the new tax is a relatively modest A$100 million each year from 2018-19.

So in what circumstances would it apply? It is hard to say with certainty.

Further guidance is awaited from the Australian Taxation Office. Many affected multinationals may be forced to rely on the “sufficient economic substance” exception, but only two examples are provided in the explanatory memorandum.
The first is where Aus Co moves its marketing and distribution functions to Foreign Co, and the profits made by Aus Co and Foreign Co must reasonably reflect the economic substance of their functions.

The second is where an electronic hardware group establishes Foreign IP Co, and the income attributed to Foreign IP Co must reasonably reflect the economic substance of its activities.

This suggests that the provisions are aimed at specific issues in the mining and technology sector, but the concepts used are general and could have much broader application. There are approximately 1,600 taxpayers with income sufficiently large to fall within its scope.

The Australian diverted profits tax includes some conditions that make it more severe than the UK version.
For example, the Australian rules have no exception for corporate debt and do not allow a credit for foreign tax paid on the diverted profits. Unlike the UK tax, which is self-assessed, Australia’s Commissioner can make a diverted profits tax assessment within seven years, payable within 21 days. The threat of assessment, paired with the more punitive 40% tax rate, will impose a very strong deterrent.

Overall, similarly to the UK diverted profits tax, it appears that a primary objective is to discourage aggressive tax planning by multinationals and promote greater openness with the tax authority.

It is imperative for multinationals to consider their cross-border arrangements carefully for potential impacts and determine whether any restructuring may be necessary to comply with the new law.

— Cameron Steele and Arthur Koumoukelis of Dentons Australia, Sydney, assisted with this article.