Australia: Multinational tax proposals; thin capitalisation and intangibles and royalties integrity measures
Treasury's consultation paper on proposed thin capitalisation changes and an intangibles and royalties integrity measure
Thin capitalisation and intangibles and royalties integrity measures
Treasury released a consultation paper on 5 August 2022 in respect of several of the government's pre-election tax policies targeting multinational entities.
The following discussion covers the two tax integrity proposals—thin capitalisation changes and an intangibles and royalties integrity measure.
The thin capitalisation rules govern the tax deductibility of interest expenses, and most taxpayers rely on the “safe harbour debt amount” test (broadly, debt limited to 60% of the average value of the entity’s Australian assets).
As part of its pre-election policies, the government is seeking to modify the thin capitalisation rules to align with the OECD recommendations coming from base erosion and profit shifting (BEPS) Action 4. The OECD’s recommended approach is a fixed-ratio rule that limits net interest deductions to 30% of “earnings before interest, taxes, depreciation, and amortization” (EBITDA). Treasury therefore proposes that the fixed-ratio rule would replace the existing safe harbour debt amount test, with a key question being whether the rule would rely on accounting or tax figures (tax EBITDA). A related issue not specifically addressed in the consultation paper is how tax EBITDA is to be computed. For example, would the addbacks for depreciation and amortisation comprise capital allowances deductions only, and would adjustments for research and development claims and tax loss deductions be required?
It is proposed that this change in test would apply to “general entities” (as defined for thin capitalisation purposes), with financial entities and authorised deposit-taking institutions subject to the existing rules, at least in the interim. This is on the basis of the OECD's acknowledgement that the fixed-ratio rule is unlikely to be suitable for these types of entities.
Treasury outlined a number of considerations for the implementation of the fixed-ratio rule, including a de minimis threshold to remove low-risk entities, and the treatment of assets or projects that provide net public benefits or are considered nationally significant.
The consultation paper does not specifically address one of the key aspects of the design of a fixed-ratio thin capitalisation test—how to deal with timing differences. This is a particularly important issue for taxpayers in industries with volatility in earnings. Most countries that have adopted the OECD recommendations have also brought in the ability to carry forward denied interest deductions for use in future years when there is excess capacity to address cyclical swings in profits, and tax professionals hope that the Australian rules will include a similar feature.
As part of the government’s pre-election policy announcement on this proposal, it stated an intention to keep the existing alternative arm’s length debt test and worldwide gearing tests. This is recognised in the consultation paper, but the paper does include a significant number of questions on the interaction of the fixed-ratio rule with these tests and the additional compliance burden (for both taxpayers and the Australian Taxation Office (ATO)) that would arise from increased use of the arm’s length debt test, indicating consideration may be given to modifying these tests as well. In particular, the consultation paper suggests that while entities can be highly geared on commercial terms allowing them to claim higher levels of deductions, it may be appropriate to strengthen the arm’s length debt test to protect against a potential misuse of this alternate test when the fixed-ratio rule would otherwise operate to deny interest deductions.
Intangibles and royalties integrity measure
This measure would broadly target cross-border arrangements involving intangibles that lead to insufficient tax paid. The government's concern here is the potential for profit-shifting to low or no tax jurisdictions using arrangements involving intangibles, which are highly mobile, and that these practices are being exacerbated by the increased digitalisation of the economy.
A key issue is the determination of when a payment would be considered to be insufficiently taxed or paid to a low or no tax jurisdiction. Options proposed by Treasury include those payments subject to tax rates of 24%, 15%, or 10% with these rates being aligned with the sufficient foreign tax test (part of the diverted profits tax rules), the Global Anti-Base Erosion Rules minimum tax rate, and the hybrid mismatch financing integrity rule, respectively. In addition, payments to jurisdictions with patent box regimes, and payments to certain nominated low tax jurisdictions, could also be in-scope.
Other matters for which consultation are sought include whether this measure would:
- Apply to large multinationals (“significant global entities”) only
- Extend beyond royalty payments to cover other types of payments including “embedded royalties”
- Apply to both related and unrelated entities.
There had been concerns that the assumptions in the Parliamentary Budget Office (PBO) costings for the pre-election policy signified a widening of the original announcement. The consultation paper asks a series of open questions, rather than signaling a firm direction for the measure. For example, unlike the PBO costings—which implied insufficient tax could be considered as tax below 24%—the consultation paper poses a number of alternative lower rates (as outlined above), which would align the measure closer to international models and Australia’s existing multinational integrity measures. However, consistent with the PBO costings, the paper does not make reference to the “dominant purpose” requirement that had appeared in the original pre-election announcement and that could signal an intention to extend the measure to a much broader range of transactions. Similarly, there is no mention in the paper of "treaty shopping.”
It is worth noting that the ATO has had a particular focus on intangibles and royalties, and is in the process of updating its draft guidance on the characterisation of receipts in respect of computer software. As such, there may be a broadening of the types of payments which the ATO would consider to be royalties, which may in turn expand the types of payments that could be caught by this measure.
This consultation paper represents the first step towards implementation of the new government’s pre-election tax policies aimed at multinationals. While not explicitly covered in the consultation paper, the government previously indicated an effective date of 1 July 2023 for these measures. Hence, timing will be tight to get the measures through the legislative process.
There is no doubt that change is coming for large business taxpayers in Australia, both in terms of what deductions they can claim and also what tax information they are required to publicly disclose. The consultation is an opportunity to play a role in reducing the risks of excessive administrative burden and unintended consequences, and in improving the likelihood of the new rules operating in a coherent way with the other (OECD) Inclusive Framework-led changes that have been proposed for the international business income tax system.
The closing date for submissions is 2 September 2022.
For more information, contact a KPMG tax professional in Australia:
Alia Lum |email@example.com
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