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Australian Senate delivers final report on inquiry into corporate tax avoidance

John Bland of Deloitte examines Australia’s recent Senate report on tax avoidance and its recommendations on thin capitalisation and transfer pricing.

The final report of the Australian Senate’s Economics Reference Committee Inquiry into Corporate Tax Avoidance was released in May 2018.

The report was the culmination of an inquiry that was established in October 2014, and that was initially expected to be finalised by 2015. Instead, 12 different hearings sessions were convened between April 2015 and March 2018, with over 100 witnesses giving evidence and three separate reports being issued as the inquiry progressed.

The inquiry released two earlier reports – Part I – You Cannot Tax What You Cannot See (August 2015) and Part II – Gaming the System (April 2016). The third and final report has been titled Part III -Much Heat, Little Light So Far.

Apart from demonstrating a proclivity for catchy titles, the final report makes 13 separate recommendations. These cover a range of tax issues, including the thin capitalisation rules, transfer pricing rules, transparency, and the Petroleum Resources Rent Tax. This article focuses on Recommendations 1 and 2, the thin capitalisation and transfer pricing-related recommendations.

Recommendation 1 states:

“The committee recommends that the thin capitalisation rules be amended so that the worldwide gearing ratio is the only method by which interest-related deductions should be calculated for the purpose of tax treatment in Australia.”

Given the already strong thin cap rules in Australia, the Australian Taxation Office’s intense focus on financing transactions in recent years, and the lack of analytical evidence provided by the relevant witnesses, it may be argued that the case for excessive debt in Australia was not entirely made out. The Australian thin cap rules already contain a worldwide gearing test as an option for taxpayers to apply; however, the inquiry recommended that the other options available (the safe harbour method and the arm’s-length debt test) be removed. The safe harbour test, broadly, permits a maximum level of gearing of 60:40 (debt to equity) and is the approach used by the overwhelming majority of affected taxpayers. The Australian government’s 2015/16 Taxation Statistics (the latest available) show that 92% of taxpayers affected by the thin cap rules applied the safe harbour test, with 6% using the arm’s-length debt test and only 2% using the worldwide gearing test.

Since the inception of the Australian thin cap rules in 1987, there has always been a safe harbour available to taxpayers, with the permitted debt-equity ratios ranging between 2:1 and 3:1. The thin capitalisation rules were updated in 2001 and a 3:1 safe harbour ratio was applied, using a broader definition of debt. The safe harbour was then reduced to 1.5:1 in 2014. Removing the safe harbour entirely would represent a significant change to the law, and would impact the approach adopted by the 92% of the taxpayer population that relies on this method.

Recommendation 2 states:

“The committee recommends that the government undertake an independent review into the detriment to Australian tax revenue that arises from the current transfer pricing regime, and explore options to modify transfer pricing rules, or other tax laws, to ensure multinational enterprises make the appropriate contribution to Australian tax revenue.”

The inquiry acknowledged the significant changes that have been made to Australian tax laws in recent years, including the modernisation of the transfer pricing law in 2012-13, and the introduction of unilateral measures such as the Multinational Anti Avoidance Law (MAAL) and the diverted profits tax (DPT). Some witnesses advocated for the inquiry to adopt more unilateral measures, while others recognised that Australia already follows the global consensus OECD approach in respect of transfer pricing matters, and that further unilateralism could lead to unintended consequences and double taxation.

The current Australian transfer pricing law follows the arm’s-length principle, and specifically references both the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations and the 2015 OECD Final Report on BEPS Action Items 8-10 as suitable reference material to guide taxpayers.  This OECD guidance sharpens the focus on matters such as the delineation of the actual transaction and allocation of returns to intangibles, among others.

Australia’s double tax agreements (DTAs) also contain the OECD-based arm’s-length requirements for associated enterprises and for branches. Australia is a signatory to the Multilateral Convention to Implement Tax Treaty Related Measures to prevent Base Erosion and Profit Shifting (MLI), the instrument that has been designed as an outcome of the OECD’s BEPS project to facilitate efficient modification of tax treaties to prevent their exploitation for tax avoidance purposes and is based on the OECD’s principles. Upon ratification, this will modify the majority of Australia’s DTAs to implement the relevant BEPS outcomes. 

Domestically, the MAAL and the DPT have been enacted to address specific issues that have been identified as risks to the Australian revenue; however, these changes do not attempt to modify the underlying conceptual transfer pricing framework or law. The proposed Australian anti-hybrid rules (Treasury Laws Amendment (Tax Integrity and Other Measures No. 2) Bill 2018) similarly seek to target specific arrangements in line with the OECD recommendations, rather than change the fundamental approach. Given this very robust Australian legal structure and its alignment with global consensus and best practice, it will be interesting to see what further modifications could be recommended or made.

It remains to be seen whether the Australian government will accept the Senate inquiry’s recommendations. The Australian Senate (the upper house of Parliament) is elected on a different basis than the House of Representatives (the lower house) where government is formed, meaning that the make-up of the Senate does not necessarily reflect the government’s view on matters. The inquiry’s report reflects this fact, with minority opinions being appended to the final report by government senators and by senators belonging to the Australian Greens party. Australia will face a federal election in the next 12 months, and if there is a change of government the inquiry report may become a roadmap for future reforms.

john Bland

John Bland 

Principal,
Deloitte Australia

jbland@deloitte.com.au

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