Facebook and Microsoft have been forced to change their operating structures in Australia to avoid being caught by tough tax avoidance laws, but could simply amending tax rates and incentivising R&D investment change corporate behaviours voluntarily?
Like many other nations, Australia has introduced a number of measures to tackle corporate tax avoidance. Beyond BEPS, it has implemented the Multinational Anti-Avoidance Law (MAAL), which entered into force on January 1 2016, and the new diverted profits tax (DPT) rules that will apply from January 1 2018. In addition, it has a 1,000-strong taskforce at the Australian Taxation Office (ATO) examining the tax affairs of multinationals to capture any unpaid taxes and has introduced a voluntary tax transparency register.
While these efforts are commended by tax justice activists, the tactics don't seem to be doing much to change the tax policies of some of the world's biggest companies.
During an August 22 public hearing on an inquiry into corporate tax avoidance, tax representatives of Apple, Facebook, Google, Microsoft and IBM revealed to the Senate's economic committee that while some of them have made adjustments to comply with the MAAL and DPT, they will still be able to benefit from the low tax rates and R&D and IP incentives offered by places like Ireland, Bermuda and Singapore.
"There were common themes in this hearing. First, a common complaint by the committee – large Australian revenues but low Australian tax. But also a common explanation – income tax is a tax on profits, not turnover, and profits are generated in the countries that create the value add. Unfortunately, that's not Australia," said Adrian O'Shannessy, director at Greenwoods & Herbert Smith Freehills. "We seem to spend all our efforts ensuring we extract every last tax dollar from the little bit of value add that does happen here, and not enough on growing the value add itself."
MNEs open about using low-tax jurisdictions
Facebook, Microsoft and Google all said they had made structural changes to comply with legislative changes in Australia, but despite this, and the implementation of the OECD's BEPS recommendations, the companies are still able to legitimately operate in certain lower-tax jurisdictions.
In Facebook's case, Ted Price, vice president of tax and treasury at Facebook, told the committee that although it has made some structural changes to comply with tax changes, it is still able to book some of its revenues in Ireland, allowing it to continue benefitting from the country's 12.5% corporate tax rate – 17.5 percentage points lower than Australia's 30% rate.
"There could be Australian advertisers who are advertising on Facebook who are not being supported by any activities done by Facebook in Australia, and those would be booked in our Irish company," Price confessed. He was open about this despite there being an ongoing audit by the ATO over transfer pricing issues – an investigation that covers most of the years the company has been doing business in Australia since 2009.
Google also said it has made some changes following the enactment of the MAAL to account for all new customer revenues related to its AdWords business to Google Australia.
However, this change appears to be where Google's tax liability to Australia ends. Damon Richardson, director of international tax at Google, confirmed that the company uses a Bermuda tax resident entity (Google Ireland Holdings) for its IP because "the Irish rules allow for [it]" and he said locating the company in Ireland and Singapore as regional hubs offers other benefits beyond tax, such as language skills. "Whether it's the ability to have folks there who are speaking the local languages or whatever it may be, there are a number of factors that play into why we're landing there – and also, from a legal perspective, legal reasons why we land in certain jurisdictions as opposed to others when we decide where to put regional headquarters."
Nevertheless, Google is being audited by the ATO for an undisclosed five-year period. Richardson confirmed that the audit is primarily related to its transfer pricing methods.
Facebook and Google have adopted buy/sell subsidiaries in Australia to comply with the MAAL, but the legislation means they can still conduct some of their Australian operations from offshore jurisdictions because the MAAL only applies where a multinational has a principal purpose of obtaining an Australian tax benefit.
Moreover, Jock McCormack, DLA Piper's head of tax in Sydney, said the MAAL "only applies to foreign entities that provide goods, services, rights or other property directly to Australian customers and thus if the Australian subsidiary deals directly with Australian customers, then generally the MAAL should not apply".
Separately, Microsoft has amended how it operates in Australia to avoid being caught by the DPT rules, but similar to Facebook and Google it has not stopped booking Australian-earned revenue in Singapore.
Daniel Goff, Microsoft's corporate vice president of worldwide tax, said the company booked about A$1.8 billion ($1.4 billion) of 2016 Australian source revenue in Singapore, of which A$740 million is booked as revenue in Australia. Goff said that the way these revenues are accounted is legitimate because the company has substance in Singapore, and his confidence in the way Microsoft operates was boosted after the company settled a tax audit with the ATO on the same day the inquiry's public hearing took place.
Goff said his company's reasoning for operating from Singapore is bigger than tax and takes the whole supply chain into account. "When you think about a supply chain, in order to sell into a market like Australia, there are a number of different pieces: there's R&D, there's the regional headquarters that has regional activities, and there are the things that happen in Australia with the local sales and marketing. Each piece of that supply chain will still be funded for their activities. There will be pieces of the Australian-sourced profit that will be taxed, or will be in these other countries."
Although Australia has introduced a DPT, this tax "should not, in principle, apply where the non-Australian associated entity has sufficient economic substance (e.g. significant R&D or other value adding activities outside Australia)," McCormack said. These companies are able to avoid the DPT's application by ensuring they have some substance in low-tax countries.
Apple was the only company that dodged questions on its offshore Irish operations, saying it cannot discuss the matter due to an ongoing state aid dispute with the European Commission. Tony King, the company's managing director, also refused to discuss Apple's 5% effective tax rate in the US, but confirmed Australia's MAAL and DPT have had no impact on the company's Australian operations.
Kerry Purcell, managing director for IBM Australia and New Zealand, said that the company has undergone a "significant transformation" over the past three years, but said that unlike other businesses, this has not been because of changing tax laws. Nevertheless, the ATO launched a tax audit against the technology company this month, Purcell confirmed.
Australia left behind
Adrian O'Shannessy of Greenwoods & Herbert Smith Freehills believes that Australia could be tackling the tax practices of multinationals in the wrong way, suggesting it is a competition issue rather than tax avoidance.
"The committee heard from these companies that product development investment is occurring in countries such as Ireland that have low company tax rates (12.5%). And regional headquarters are located in countries like Singapore that also have low company tax rates (17%). Australia's 30% company tax rate was low when it was introduced in 2001, but we've been left well behind competitor countries now," O'Shannessy said. "The Australian company tax rate is scheduled to fall to 27.5%, but not until 2023 for large companies. In the current world order that's scant encouragement for the behaviour we most need, more investment in Australia."
John Taylor, professor at the School of Taxation and Business Law at the University of New South Wales, agreed that plans to eventually cut the corporate tax rate to 25% by fiscal year 2026/2027 will not help because the "rate is not internationally competitive now and will not be in 10 years' time", he said. "As MNEs investing or doing business in Australia currently pay so little Australian tax it is unlikely that a reduction of the corporate rate to 25% will have much effect if any on their behaviour."
However, Mark Zirnsak from the Uniting Church in Australia, who also spoke at the public hearing and campaigns for tax justice through his role as the secretariat for the Tax Justice Network Australia, believes that no changes will make a difference to MNE tax practices until all avenues for tax-minimisation are blocked. Moreover, he said the OECD has failed to achieve its objectives on BEPS.
"There are still gaps around artificial debt loading by multinational corporations. Disappointingly, through the OECD base erosion and profit shifting programme, we think there's been a significant failure by the OECD to substantially address the issues around transfer pricing, the digital economy and harmful tax practices. That has led to the need for things like the diverted profits tax simply because the multilateral efforts to deal with transfer pricing haven't worked," he said.
"The issue here is that corporations, which have been used to dodging or cheating on their taxes for a long time, and that's part of their culture, are just not going to give up because the government makes certain reforms in some areas," he continued. "They are always going to look for the loophole and the next strategy they can adopt to avoid paying the taxes they should be paying. This is going to require sustained effort; there is a need to block all the loopholes and to be vigilant as to what the next game might be."
From the views aired during and after the inquiry's public hearing, it seems introducing more tax compliance measures, lowering the rates, or even offering more incentives, will not be enough to change the behaviours of multinationals. In a global and increasingly digital world where tax competition will continue to exist, MNEs will always find a country that offers what they need. The difference now, however, is that they have to have substance in those jurisdictions. Unfortunately, it seems Australia is just not offering what big businesses want.
