Recent years have seen an unprecedented global, coordinated response to the 15 Action Items recommended by the OECD following its Base Erosion and Profit Shifting (BEPS) project, a process in which Australia, and the ATO, has been at the leading edge.
At the 51st Western Australia State Convention in August, Matt Popham, CTA, (KPMG), presented the session ‘The post BEPS world – Lessons learned’.
Speaking to us before the event, Matt said “The various BEPS initiatives that have been implemented over the years have been translated into practices that actually impact Australian businesses. Looking at these practices and how the ATO are seeking to implement new initiatives can be used, together with what is happening around the world, to help us predict what will come in the future.”
Next year Matt will present at our National Convention in Hobart, in the session ‘Australia’s Responses to the BEPS OECD Project – What is the Reality?’, where he will peer through the fog of these legislative and administrative developments and reforms to provide an update on the practicalities of Australia’s response to various BEPS-related initiatives, focusing on practical examples where the DPT, MAAL, MLI and anti-hybrid rules can apply to Australian taxpayers.
In this post we excerpt his original paper from August, and look at a few of the lessons so far.
The OECD’s Base Erosion and Profit Shifting Project set out 15 Action Items, with recommendations for each being reported in 2015. Those recommendations have then been taken up in various forms by tax authorities around the World, with the UK and Australia seemingly taking the lead.
In Australia, some time has now passed since the ATO embraced the BEPS philosophies and the initial ‘Post-BEPS’ legislation became law. As a result, it is an opportune time to take stock of where we are and what lessons can be learned from the recent past to help companies and their advisers understand how they can best respond.
In the paper, Matt points out there has been quite a bit of activity in the recent past with regard to the treatment of multinational enterprises and cross border transactions. Whilst the new legislation is still in its infancy, recent interactions with the ATO have ensured that companies and their tax advisor can learn a number of key initial lessons.
The ATO doesn’t like inbound debt
Highlighted in the paper are a number of new measures, both from a legislation perspective and ATO approach, which are centred fair and square on limiting related party inbound debt. Given the tax profile of large multinational groups in Australia, this is not surprising.
During FY2016, the ATO have highlighted that total inbound related party loans totalled $420 billion. The interest on such loan balances therefore provides a significant tax shelter against Australian assessable income and results in a very significant reduction in Australian tax payable, even after factoring in interest withholding tax.
In response to this the ATO have created a new internal group that is purely focused on reviewing related party financing arrangements and the new group are comfortable with seeking to apply the full range of measures at their disposal to limit interest deductions. For example, Matt points to the experience of the ATO considering the potential application of both the new DPT and general anti-avoidance legislation to a relatively straightforward refinancing of an Australian subsidiary by an overseas parent that would, in part, fund a dividend payment.
The ATO’s approach has been bolstered by both the new legislative weapons at its disposal, as well as the Chevron case decision, and is pro-actively reviewing sizeable financing arrangements. Of the $420 billion of inbound related party loans, some $150 billion is either under review or already been reviewed. The risk framework introduced in PCG 2017/4 is also providing the ATO with the ability to have different conversations with taxpayers, particularly measures that can be taken by taxpayers to avoid lengthy audit or review activity, such as reducing interest rates to be in line with their group cost of debt. The approach is clearly working as some $75 billion of debt has either been moved into the green zone or otherwise settled with the ATO with a reported associated reduction in interest deductions in FY2017 of $1.5 billion.
The ATO has put a clear stake in the ground and it is now up to taxpayers and their tax advisers to determine how they wish to respond. With increased disclosure on the Australian Local File and Reportable Tax Positions Schedule of PCG risk rating outcomes, taxpayers will need to take a more pro-active approach to engaging with the ATO than perhaps they would have considered in the past.
Multinational groups will also need to consider whether the ease of receiving funding from their parent entity is worth the additional ATO scrutiny or whether it is now preferable to seek its own local external funding. In my discussions with the ATO, the latter is far more acceptable to them, even where it results in similar outcomes in terms of Australian interest deductions and Group consolidated debt levels.
The Australian tax position is impacted by what happens overseas
In years gone by the Australian tax position was dependent upon what happened within these shores, but that is no longer the case. When it comes to assessing the application of the anti-hybrid rules or the Diverted Profits Tax to related party transactions, the tax profile of the non-resident counterparty or the tax system within which it operates will now influence the Australian tax position.
In addition, under the new marketing hubs PCG, the price at which goods should be sold by the Australian resident company is dependent upon the cost structure of the non-resident hub entity. The impact of this change cannot be underestimated. The ATO are already seeking far greater detail regarding the activities of non-resident entities when considering Tax Ruling applications involving related party transactions. When considering the potential application of the Diverted Profits Tax for example, the ATO are reviewing in detail each and every non-resident entity involved in the arrangement and considering the commerciality of the arrangement from the perspective of each entity involved.
Further, the potential for the anti-hybrid legislation to deny Australian tax deductions is completely dependent upon the tax treatment in the overseas jurisdiction of either the entity itself or the corresponding income receipt and/or whether hybrid arrangements exist between two non-resident entities that interact with the Australian group in some way.
It also means that the Australian tax position is susceptible to future changes in overseas tax legislation. For example, a move by a sovereign nation to improve its attractiveness as a holding company location by treating dividend (including Redeemable Preference Share dividends) and/or interest income received from foreign subsidiaries as exempt income would cause Australian tax deductions to be denied, even where existing arrangements had not been established to benefit from such a mismatch.
It means that Australian subsidiaries and their tax advisers need to be far more aware of the broader tax profile of the group outside of Australia and also be able to access underlying documentary evidence of overseas arrangements to provide to the ATO if requested. This has the knock-on impact of meaning that overseas entities will need to ensure it has in place contemporaneous documentation supporting the commercial drivers of arrangements in order to satisfy the ATO. This therefore means that the broader group and their own advisers need to be educated on the changing Australian landscape.
The ATO are trying to influence taxpayer behaviour
The ATO have been very clear in recent times that they are wanting to be more transparent with taxpayers with respect to how they assess a taxpayer’s tax risk profile. The release of the PCGs is completely consistent with that policy and their other stated approach of wanting to encourage taxpayers to ‘swim between the flags’.
Whilst this approach is to be applauded, the concern from the PCGs is that the ATO are setting the bar very high. With regard to inbound financing, a debt arrangement would be expected to fall outside the green zone in any of the following situations:
- A non-parent/treasury counterparty in a country with a 15% tax rate;
- A non-parent/treasury counterparty in a country with a 20% tax rate and with Australian interest cover of less than 4.2;
- Australian leverage of greater than 60%, even in asset-intensive industries where asset-backed finance is commonplace;
- Interest rate set at more than 50 basis points above the relevant referable debt/group cost of debt; or
- Loan terms do not specify any collateral
The ATO are at pains to outline that simply because a taxpayer is not in a ‘green zone’ it does not mean that the underlying arrangement is wrong or inconsistent with transfer pricing principles.
However, at the same time, they set out in much detail what a taxpayer can expect from the ATO if they do not comfortably sit in the low risk category. This is in the clear hope that taxpayers will decide to err on the side of caution when setting intercompany prices to avoid incurring additional ATO scrutiny that will inevitably lead to additional time and cost commitments that they would prefer to use elsewhere.
Tax authorities are playing…..for now
Matt’s paper notes that it is the clear hope of the ATO that taxpayers will err on the side of caution from an Australian perspective when pricing intercompany transactions. This may well have the impact of reducing audit activity in the short term, however it will increase the risk of a transfer pricing enquiry in the overseas jurisdiction in which the counterparty is located.
At present, the majority of the OECD countries are singing from the same hymn sheet and whilst some countries such as Australia and the UK are leading the way, the majority of countries are in the process of systematically putting in place similar legislation, particularly with regard to hybrid mismatch arrangements. The speed at which the MLI was conceived, designed and implemented is another indicator that countries are happy to work together for the common good, particularly where the focus is on growing the global tax pie (i.e. by limiting tax deductions). It will however be another story when, for example, the increased tax disclosure information begins to be reviewed by different tax jurisdictions and debates begin regarding the distribution of the tax pie between those different jurisdictions.
The expectation is that with the increasing disclosure of tax relevant information, increased audit activity will inevitably rise as different tax jurisdictions squabble over their entitlements. Unfortunately it will be the poor taxpayer that will be caught in the middle of the competing objectives of different tax authorities with a resultant increase in compliance costs.
Substance is very important
As noted multiple times throughout his paper, Matt points out that the substance of arrangements and the commercial drivers for transactions have never been more important. The majority of the new BEPS related measures have exclusions where substance and commerciality can be proven.
However, due to the changing tax landscape, the ATO now have the ability to review the substance and drivers of purely overseas transactions (i.e. transactions between two non-resident counterparties). The ATO have already proved that they are fully embracing their new powers. In addition, the way in which the Diverted Profits Tax administration rules operate provide the ATO will the opportunity to effectively force SGEs to provide all the information the ATO requests within a relatively short time window. Multinational groups have to adapt accordingly and ensure that appropriate contemporaneous documentation is prepared and retained.
The rest of the paper looks in more detail at the key themes of BEPS, namely that substance is king, the drive towards more global consistency, and increased disclosure and information requirements. Matt then looks at Australia’s legislative responses, along the lines of these key themes, and the ATO’s approach and activity, including the focuses on increasing assessable income and on reducing tax deductible expenditure.
At the 2019 National Convention in Hobart, Matt’s session ‘Australia’s Responses to the BEPS OECD Project – What is the Reality?’ will focus on the practicalities of Australia’s response to various BEPS-related initiatives, focusing on practical examples where the DPT, MAAL, MLI and anti-hybrid rules can apply to Australian taxpayers. The session will also briefly cover some of the mechanisms available to the ATO under domestic tax law to implement the BEPS initiatives.
Matt is a KPMG Tax Partner with almost 25 years tax experience. Leading the International Tax Advisory Group at KPMG in Perth, Matt has significant experience in advising multinational groups on the ever-increasing tax complexity and legislative change associated with the BEPS initiatives and cross-border transactions. Matt is a previous chair of The Tax Institute’s WA State Council and regularly presents and lectures on international tax and BEPS matters.
Find out more about Matt's session and the rest of the 34th National Convention program on our website. Register before 7 December and save $400.