The Australian Taxation Office (ATO) released a Taxpayer Alert (TA2018/2) on November 20 2018, summarising its concerns regarding the “mischaracterisation” of activities/payments in connection with intangible assets.
The ATO issues Taxpayer Alerts to highlight its concerns about certain arrangements that it considers to be high risk, and to outline the ATO’s approach to such arrangements.
Broadly, TA2018/2 describes arrangements whereby payments made by Australian entities that are partly for the use of intangibles may be mischaracterised as payments solely for goods or services. Specifically, the ATO has outlined the arrangements that may be more likely to result in a mischaracterisation. These include:
Arrangements that allocate all consideration to tangible goods and/or services;
Arrangements that allocate no consideration to intangible assets; and
Arrangements that treat intangible assets collectively or conceal intangible assets.
TA 2018/2 states that these situations have been observed to arise in arrangements whereby an offshore party owns and maintains intangibles offshore, and the Australian entity enters into an agreement to undertake activities in Australia (such as manufacturing, marketing and distribution of products).
These activities require the use of those intangibles, as well as the purchase of goods/services from the offshore entity. The payments made by the Australian company under the agreement do not recognise the use of the offshore party’s intangibles.
As a result of these arrangements, a potential royalty element of the payment may be bundled into the price of the goods and/or services, and it is not separately recognised. Although TA 2018/2 does not use this term, such arrangements are sometimes referred to as embedded royalties.
The focus of TA 2018/2 is on this “undivided consideration,” which may be a payment for separate items for both the goods/services and the use of the associated intangible.
The potential consequences that may arise from such a mischaracterisation include:
Failure to comply with royalty withholding tax (RWT) obligations associated with consideration for the use of intangibles (Australia imposes a RWT of 30% on royalties paid offshore, reduced under income tax treaties to between 5% and 15%);
The royalty element of the payment is not deductible by the payer if the RWT is not paid;
A transfer pricing benefit to the offshore company in the form of unpaid withholding tax may arise; and
If the ATO concludes that the principal purpose of the arrangement is to obtain a tax benefit, the general anti-avoidance rules may come into play.
While TA 2018/2 focuses on related-party arrangements, the ATO’s concerns could also be relevant in arrangements between third parties.
TA 2018/2 provides two general examples that outline the kinds of arrangements the ATO focuses on. However, taxpayers should note that TA 2018/2 is not intended to apply to international arrangements that involve the incidental use of an intangible asset. For example, the ATO states that TA 2018/2 will not apply to Australian re-sellers of finished tangible goods when the activity of reselling the goods involves an incidental use of a brand name that appears on the goods and related packaging.
Determining if the use of an intangible asset is incidental will depend on an analysis of the true relationship and activities of the parties, and the fact that an arrangement fails to provide expressly for the use of an intangible asset does not, in itself, determine that the use is incidental.
Next Steps
Taxpayers who participate in, or are contemplating arrangements whereby they undertake activities in Australia using offshore intangibles, should consider whether those arrangements are of the type described in TA 2018/2.
Moreover, taxpayers should seek advice on the arrangements, particularly regarding whether the payments (or part thereof) may be treated as a royalty under Australian law or any relevant income tax treaty. The characterisation and apportionment issues involved can be complex.
The ATO indicates that it is currently undertaking compliance activities regarding these arrangements, and that it is continuing to develop its technical position in this area. Taxpayers the ATO considers as higher risk will be subject to increased scrutiny and are encouraged to engage with the ATO to discuss their situation.
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John Bland |
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Milla Ivanova |
This article was written by John Bland and Milla Ivanova of Deloitte Australia.
John Bland, Principal
Deloitte Australia
Email: jbland@deloitte.com.au
Milla Ivanova, Graduate
Deloitte Australia
Email: milivanova@deloitte.com.au
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