Introduction
In the October 2022-23 Federal Budget, the government announced its intention to introduce an anti‑avoidance measure to prevent large multinationals from claiming tax deductions for payments relating to intangibles connected with low corporate tax jurisdictions. On 31 March 2023, Treasury released exposure draft legislation proposing to introduce an anti-avoidance provision in the form of section 26-110 of the Income Tax Assessment Act 1997 (Cth) (1997 Act). Our Alert on that exposure draft can be found here.
The new rule is designed to deter significant global entities (entities with annual global revenue of at least $1 billion) (SGEs) from structuring their arrangements so that income from exploiting intangible assets is derived by an associate in a low or no corporate tax rate jurisdiction, while tax deductions for payments attributable to intangible assets made by the SGE to an associate are claimed in Australia. This rule will prevent the SGE from claiming tax deductions for such payments.
The proposed amendments will apply to amounts paid, liabilities incurred or amounts credited on or after 1 July 2023.
On 22 June 2023, the Government introduced Treasury Laws Amendment (Making Multinationals Pay Their Fair Share – Integrity and Transparency) Bill 2023 (Bill) into Parliament addressing two key aspects of its multinational tax integrity measures (our Alert on that Bill can be found here). The explanatory memorandum to the Bill noted that the Government would continue consultation on the aforementioned intangibles measures and consider their interaction with Pillar Two. The following day, and with much less fanfare than the Bill, Treasury released revised exposure draft legislation in the form of Treasury Laws Amendment (Measures for Future Bills) Bill 2023: Deductions for payments relating to intangible assets connected with low corporate tax jurisdictions (Exposure Draft).
Our key observations on the Exposure Draft are set out below.
Overall, while we acknowledge that Treasury has taken into account a number of submissions from industry in releasing the revised exposure draft, key concepts within the Bill remain exceptionally broad in their application.
Please contact one of the authors should you wish to discuss the Exposure Draft and its potential impact.
Key takeaways
The core concepts of the provision remain broad
The text of proposed section 26-110 has been amended in response to consultation and to better achieve the policy intent of the provision. However, the scope of the proposed measure remains, by design, extremely broad. For example, consistent with the earlier exposure draft legislation:
- “exploit” includes a range of activities beyond the use of an intangible asset, including in relation to any permission to exploit an intangible asset in the same way as it applies in relation to a right to exploit
- the payments that may be subject to the proposed measure extend beyond “royalties” (under the Income Tax Assessment Act 1936 (Cth) (1936 Act) and under common law)
- there is no requisite purpose (sole, dominant, principal or otherwise) test before the proposed measure will apply. In the absence of a ‘purpose test’, it remains difficult to see how the proposed measure would not apply other than in very specific circumstances where the prescriptive requirements are otherwise met (but subject to the limitation of the application of the provision discussed below)
- apportionment remains an issue, with a deduction being denied “to the extent that the payment is attributable to a right to exploit an intangible asset”. This is amplified by the reference in a new example in the explanatory materials to the Exposure Draft (EM) to part of a payment being considered to be an embedded royalty where, in addition to a payment being made for services, there is also considered to be some exploitation of an intangible asset.
Payments made, and income derived, indirectly through interposed entities
The Exposure Draft itself (rather than the EM) now provides, for the purposes of determining whether a payment is made indirectly through one or more interposed entities to an entity, and where income is derived indirectly through one or more interposed entities, that it is sufficient if amounts are paid or transferred between each entity. That is, it is not necessary to demonstrate that each payment or transfer in a series of payments or transfers funds the next payment or transfer, or is made after the previous payment or transfer.
This view is consistent with the language used in the imported hybrid mismatch rule in Subdivision 832-H of the 1997 Act and the broad interpretation adopted by the ATO in PCG 2021/5. However, unlike the imported hybrid mismatch rules, there are no limiting conditions on the scope of the possible analysis of payments and transfers. This may present a compliance burden for taxpayers.
Some limiting of the application of the provision
While the core concepts of the proposed measure remain broad, amendments have been made that reduce the application of the provision. We welcome such amendments.
(a) Definition of low corporate tax jurisdiction
Amendments have been made to the definition of ‘low corporate tax jurisdiction’ to:
- clarify that it is the national headline corporate income tax rate that is relevant for the purposes of determining whether a jurisdiction is a “low corporate tax jurisdiction”. For example, exemptions for particular industries and for particular types of income are disregarded when determining if the rate of corporate income tax under the laws of a foreign country is less than 15%, or nil; and
- provide, in determining the rate of corporate income tax in a jurisdiction, that only the income tax rates applicable to income derived in the ordinary course of carrying on a business are relevant.
Further, in determining if income has been derived in a low corporate tax jurisdiction by an associate, income will be disregarded to the extent it:
- is subject to foreign income tax at a rate of at least 15 per cent. For this purpose, State and municipal taxes will be included. In addition, if the payment is subject to foreign income tax at a rate of 15 per cent or greater because of the application of foreign hybrid mismatch rules of a foreign country, it may be considered as subject to foreign tax for this purpose; and
- has been taken into account under section 456 or 457 of the Income Tax Assessment Act 1936 and assessed to any taxpayer as attributable income under the Australian CFC regime.
(b) Interaction with royalty withholding tax
Where:
- a deduction would otherwise be denied because of the operation of section 26-110;
- the taxpayer has withheld an amount from a royalty payment and remitted it to the Commissioner as required; and
- no other provision denies a deduction,
the amount of the deduction denied will be reduced to reflect the withholding tax paid.
The amount of the reduction is the amount paid to the Commissioner divided by the corporate income tax rate that applies to the SGE. Therefore, where the full payment by a taxpayer to an associate is characterised correctly as a royalty and an amount is withheld from that royalty at a rate of 30 per cent and remitted to the Commissioner, the full amount of the royalty will be deductible despite the operation of section 26-110 (provided no other provision denies the deduction).
Further guidance still required
While some additional examples have been included in the EM, these are mostly in respect of the amendments set out above. For such a measure – and having regard to the concerns addressed above and in our previous Alert on the proposed measure – we would have hoped to see further examples.
The ultimate scope of the proposed measure will now depend upon the ATO providing practical guidance in a timely manner. The intention of the ATO to provide such guidance was flagged in Attachment 2 of the explanatory memorandum to the Bill. We understand the interactions with Pillar Two global and domestic minimum taxes will be considered during Australia’s implementation of those measures.
Specific penalty provision now introduced
To complement the proposed measure, amendments have been made to double the base penalty amount where the penalty results from an application of section 26-110. This is in addition to the doubling of the base penalty amount that already applies to a penalty of an SGE for making a false or misleading statement (i.e. the base penalty amount may be quadrupled where the penalty results from an application of section 26-110).
We consider that the existing ‘statement’ penalty regime is sufficient penalty and that the imposition of a further penalty should not be introduced. This is particularly the case given the breadth of the provisions, the lack of a purposive requirement and the retrospectivity of section 26-110 (discussed below).
Commencement date remains 1 July 2023
With a 1 July 2023 commencement date, taxpayers should review the Exposure Draft as soon as possible to determine whether their arrangements regarding intangible assets may be subject to the proposed measure and, if necessary (or possible), to restructure such arrangements. This is particularly important given the punitive penalty regime that is now proposed, for legislation that will operate retrospectively once it becomes law.
