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New powers to tax offshore booking of Australian customer sales

Geoff Gill and Priscilla Ratilal, of Deloitte Australia, discuss the Australian government’s increased focus on anti-avoidance measures to tax offshore bookings of Australian customer sales, particularly in relation to marketing operations.

Multinational corporations operating in Australia with marketing operations and customer sales booked offshore have been on notice for some time that these operations will come under close scrutiny by the Australian Taxation Office from a transfer pricing and permanent establishment (PE) perspective.

However, a new focus is emerging with the Australian government's release of draft legislation extending anti-avoidance provisions to those situations.

In May 2015, an integrity measure specifically aimed at addressing multinational tax avoidance was announced as part of the 2015-16 Australian federal budget. Simultaneously, Treasury released exposure draft legislation on this topic:- draft Tax Laws Amendment (Tax Integrity Multinational Anti-avoidance Law) Bill 2015 (MAAL).

The Australian government's primary focus is to target the technology sector, which the government believes aggressively uses low-tax jurisdictions as booking locations for Australian customer sales. However, the law, when enacted, could also significantly affect the financial services and financial technology (fintech) sectors.

This article provides a review of the basic mechanics of the new law, identifies a number of important features, and discusses the implications of the new law and associated ATO compliance activity for the financial services and fintech sectors.

The proposed law

The explanatory memorandum (EM) released with the exposure draft legislation indicates that the new provisions are intended to target only "the most egregious tax structuring by multinational entities, while limiting the impact on legitimate international business activities".

The EM explains that the draft legislation will introduce changes to Australia's general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to "negate certain tax avoidance schemes used by multinational entities to artificially avoid the attribution of business profits to a permanent establishment in Australia". The significance of including the MAAL in Part IVA is that Part IVA generally overrides Australia's tax treaties. As a result, the intention is to allow a PE to be deemed to exist under Part IVA, even though no such PE would exist under the relevant treaty.

The draft legislation targets both the business profits that could be attributable to a deemed Australian permanent establishment and obligations arising under royalty and interest withholding tax.

Effectively, the tax rate on such profits could be as high as 60% (that is, the statutory Australian corporate tax rate of 30% plus a 100% penalty).

The measure will apply when:

  • A nonresident of Australia makes a supply to an unrelated Australian resident;
  • The income derived by the nonresident is not attributable to an Australian permanent establishment of that nonresident;
  • Activities are undertaken in Australia in connection with the supply;
  • Some or all of those activities are undertaken by an Australian resident (or an Australian permanent establishment of an entity) which is an associate of, or commercially dependent on, the nonresident;
  • It is reasonable to conclude the scheme is designed to avoid the nonresident deriving income attributable to an Australian permanent establishment of the nonresident;
  • A principal purpose is to enable a taxpayer (the nonresident or another entity) to obtain a tax benefit, irrespective of whether the scheme also reduces foreign taxes or other Australian non-income taxes (such as the goods & services tax (GST)); and
  • The foreign resident is connected with a no-tax or low-tax jurisdiction (see below).

A global revenue threshold of AUD 1 billion ($700 million) will be applied – multinationals must have global sales exceeding that figure for the measure to apply to them.

The measures will apply to tax benefits arising on or after January 1 2016, irrespective of the date the scheme was entered into or commenced.

Broad scope of dealings

The measure potentially will apply to nonresidents with a broad range of dealings with Australians, including but, importantly, not limited to, "the supply of electronic material, advertising services, downloads, the provision of data, intellectual property rights, and the right to priority in search functions".

The legislation will apply only when the nonresident deals with an Australian resident who is not an associate. Therefore, supplies made by nonresidents to or through an Australian subsidiary should not be caught.

Foreign taxes are relevant to purpose test

The Australian government has recognised that focusing only on Australian tax benefits could be problematic for this measure. The EM provides an example of a group that uses an identical structure throughout the region and that has been designed to avoid the creation of permanent establishments in a number of countries in the region. The Australian operations are a relatively small part of the group's regional operations.

Ordinarily, it would be possible to argue in such a case that any purpose of obtaining an Australian tax benefit was only a minor purpose of the overall structure, given the relatively small size of the Australian operations. The draft legislation seeks to counteract this argument by testing purpose with regard not only to the Australian tax benefit but also to foreign income tax benefits and Australian non-income tax benefits (such as GST).

It should be noted that while purpose is tested with regard to all of these taxes, only the Australian tax benefit (as determined under the Part IVA rules) can be attacked under this measure – in other words, the measure does not seek to prevent avoidance of foreign taxes or Australian taxes other than income tax.

Profits "channelled" to tax havens

While the Treasurer's announcement referred to profits channelled to tax havens, the draft legislation includes what is arguably a much broader category of profits. The measure will apply when a nonresident is "connected with" a no-tax/low-tax jurisdiction. This will be the case when the nonresident or any other member of its global group conducts any activities that give rise to income that falls within either of the following categories:

  • Income subject to no tax or a low rate of tax by virtue of either a law of a foreign country or an arrangement with the government or an authority of a foreign country. It is important to note that a "low rate of tax" is not defined either in the legislation or the EM.
  • "Stateless income" – income that is not subject to tax in any country.

Many multinationals could potentially come within this aspect of the test, because multinationals need to look beyond the particular nonresident entity making the supply, and consider if the income further up the value chain is subject to no tax or low tax. However, there are two carve-outs:

1) When the activities generating the no-tax or low-taxed income are not related directly or indirectly to the Australian dealings, or

2) When the entity undertaking the activities undertakes "substantial economic activity" in the no-tax or low-tax country.

It is important to note that the key terms "substantial economic activity" and "low tax" are not defined.

The onus of proof for these two carve-outs will be on the taxpayer.

Implications for financial services

Origination activities whereby the ultimate supply is made by a separate legal entity to the marketer/originator are very common in financial services. Consider the situation whereby trades, loans, or leases are introduced by one part of a group to another offshore booking entity, which has the capital and/or trade risk management capabilities. The trades, loans, or leases may be introduced by a subsidiary that is responsible for the local client liaison function, or potentially by a representative office whose activities are arguably preparatory or auxiliary and therefore the representative office has not reached the threshold of creating a permanent establishment under the current law.

Within banking enterprises, such arrangements are often commercially dependent on capital efficiency and location of expertise. However, it may be the case that these booking entities are located in low-tax jurisdictions, or have received reduced tax rates from local fiscal authorities to encourage economic activity. It is also potentially the case that there may be a separation of functional activity from the booking entity, and the remote booking may be enabled by technology platforms. In those situations, when the product supply is to/with an Australian customer, the potential applicability of the new MAAL should be considered.

Digital disruption continues apace in financial services, particularly in mature markets such as Australia. There is a significant amount of innovation in financial services around payments, online brokerage, currency exchange, small business and peer-to-peer lending, and wealth management. There are also many software companies focused on solutions for the financial services sector. In some situations, the new MAAL could apply to those companies when offshore residents sell product to Australian customers that is enabled by local marketing and origination activity.

Managing risk in the current environment

The ATO is actively testing whether, under current laws, Australian marketing operations perform sufficient activity regarding negotiation of sales to result in the creation of a PE in Australia of the offshore resident sales booking entity. Similarly, the appropriateness of transfer pricing policies to reward the originating entity is being tested in the field, with approaches that may vary from cost plus/transactional net margin method (TNMM) using a cost-based profit level indicator, to commissions on sales and profit splits.

For example, in 2013 the ATO sent a questionnaire to all inbound banks regarding online banking platforms and local marketing activity.

The new MAAL is a significant measure that multinationals in the financial services space will need to consider carefully. Given the level of activity regarding sales/marketing/origination activities, multinationals should review their current arrangements to consider their risk from a transfer pricing, PE, and (now) MAAL perspective.

In terms of risk management with regard to the proposed MAAL and associated compliance activity, some options available to MNCs include:

  • Preparation of analysis and a defensive paper rebutting the potential applicability of the MAAL, having regard to the fact that the new law places the onus of proof on the taxpayer to prove the law would not apply (for example, a substance test).
  • Reviewing the pertinent facts as to whether, under existing law, a permanent establishment is likely to exist, and preparing defensive documentation.
  • If the risk of application of the MAAL is high enough, consider more proactive measures, such as:
  • Recognition of a deemed permanent establishment, and attribution of profits to that PE under OECD principles.
  • Booking of the sales revenue in the subsidiary entity, subject to systems capacity and other commercial and tax impacts
  • Reviewing the transfer pricing method to reward the subsidiary, which could be modified to a sales-based profit allocation, or profit split.

In some situations, it may be appropriate to manage risk through a proactive approach to the ATO in the form of an advance pricing arrangement, which could achieve certainty on the attribution of profits to the subsidiary and any deemed permanent establishment.

Conclusion

Offshore booking of sales and trading revenue when the ultimate customer is in Australia carries current and emerging tax risks. Because those models are reasonably common in the financial services and fintech sectors, such risks need to be evaluated and managed.

Geoffrey Gill

Partner – Transfer Pricing
Deloitte Touche Tohmatsu

225 George Street
Sydney NSW 2000
Tel: +61 2 9322 5358
gegill@deloitte.com.au

Professional experience

Geoff Gill is a partner and economist with Deloitte's Global Transfer Pricing group in Sydney.

Geoff has over 16 years of experience in transfer pricing, and has worked in both London and Sydney. Geoff leads Deloitte Australia's transfer pricing practice for the financial services industry. Geoff also specialises in and has extensive experience in the analysis of financial transactions.

Geoff was nominated as a World's Leading Transfer Pricing Adviser in Euromoney's 2013 guide and, recently, in its new 2015 guide.

Skills and expertise

Geoff has successfully completed a wide range of bilateral and unilateral advance pricing arrangements and audit defense projects. Geoff advised on the first completed joint transfer pricing audit between the ATO and IRS.

Geoff has published articles on loan guarantees, debt financing and the transfer pricing case law in international journals and speaks regularly at external seminars. Recently, he has been closely involved in working with the Australian Treasury on the reforms to Australia's transfer pricing rules and on the Inspector General of Taxation's review of the ATO's approach to transfer pricing compliance.

Industry specialisation

Geoff's work covers a wide variety of industries. However his focus areas include:

  • Financial services – Transfer pricing advisor to a number of retail and investment banks, property trusts, fund management and brokerage companies
  • Telecommunications Media and Technology – including setting global transfer pricing policies and ATO controversy
  • Debt pricing – analyses for a wide variety of debt instruments, guarantee fees and determination of arm's length debt levels.

Professional and academic qualifications

  • Master of Philosophy in Economics, University of Oxford
  • Bachelor of Economics (Honours), Trinity College, Dublin
  • ACCA Diploma in Accounting and Finance
  • Affiliate of Institute of Chartered Accountants in Australia
  • Member of Tax Institute of Australia

Priscilla Ratilal

Account Director – Transfer Pricing
Deloitte Tax Services

225 George Street
Sydney, NSW 2000
Tel: +61 (2) 9322 5086
pratilal@deloitte.com.au

Professional experience

Priscilla Ratilal is an account director with Deloitte's transfer pricing group in Sydney, Australia.

Priscilla has advised multinational clients on a wide range of transfer pricing matters including audits and risk reviews by the Australian Taxation Office (ATO), the negotiation of unilateral and bilateral advance pricing arrangements (APAs), planning strategies and transfer pricing documentation to support tax return filing positions.

Priscilla was based in an investment bank in New York for two years as the transfer pricing manager for the Americas. Her role included oversight of transfer pricing compliance in the US, Canada, Mexico, Brazil and Argentina, advising on transaction structuring from a transfer pricing perspective and management of transfer pricing audits by the US Internal Revenue Service and Canada Revenue Agency.

Priscilla specialises in financial services transfer pricing and the pricing of intra-group financial transactions. Her relevant experience includes:

  • Pricing of intra-group guarantee fees and lending, including inter-branch funding for multinational banks;
  • Analysis to determine arm's length gearing levels;
  • Transfer pricing analysis and attribution of profits in the global dealing of FX, bonds, equity swaps;
  • Preparation of transfer pricing documentation and assistance in a revenue authority risk review on the global trading of commodities and commodity derivatives;
  • Attribution of profits for lending activities performed in multiple branches;
  • Allocation of investment banking fees to remunerate cross-border involvement in M&A advisory, DCM and ECM activities;
  • Preparation of transfer pricing documentation and audit defence for management service charges in an equipment leasing business; and
  • Transfer pricing due diligence for mergers and acquisitions.

Qualifications

  • Bachelor of Arts (Economics and English) – University of Sydney
  • Bachelor of Law – University of Sydney
  • Masters of Law (Taxation) – University of Sydney

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