Energy and Resources Working Group minutes 17 October 2019

Attendees

Apologies

Agenda item: 1 - Introduction and key messages

The ATO expects to provide a survey and the ERWG charter to members, seeking feedback with respect to the purpose and effectiveness of the group, including:

• whether the external members are getting enough value from this group as the ATO notes it tends to focus heavily on providing information to members
• group make-up, including whether there is enough consistency, noting that it is the intention to rotate membership every two years
• the appointment of a co-chair, as well as giving an external member the formal responsibility of chairing meetings
• whether the group should continue going forward.

The ATO will appear at Senate Estimates in the week beginning 21 October 2019.

The ATO is likely to make a submission to the Senate inquiry into Australia’s oil and gas reserves.

The Commissioner of Taxation annual report 2018–19 will be published shortly. In the meantime, the large corporate group's income tax gap and PRRT gap were published on 17 October 2019. The large corporate group's income tax gap saw an improvement in the net gap from the previous year. In general, we are trending towards having a 96–98% gap by 2024.

Agenda item: 2 – Minutes from previous meeting and action items

There were no objections to the minutes of the meeting held on 26 March 2019 (published on 19 June 2019) and no follow-up action items.

Agenda item: 3 – Industry response to the OECD project on digitalisation of the economy – presented by the MCA

The OECD has released a public consultation document titled ‘Secretariat Proposal for a “Unified Approach” under Pillar One’, relating to Tax Challenges Arising from Digitalisation (BEPS Action 1).

The OECD is seeking submissions by 12 November 2019.

The proposal may address the failings of the arm’s length principle, which was previously supported by the OECD as the most appropriate method for allocating profits.

Agreeing on a unified approach will be challenging, as there are 135 countries in the Inclusive Framework on BEPS. However, the release of this document may indicate that there is already a level of support.

The proposed approach involves a new nexus rule which is ‘unconstrained by physical presence requirements’ and allocates a share of taxing rights to the market user jurisdiction on non-routine profits. It attempts to address concerns relating to businesses which do not have a physical presence in the market jurisdiction.

The scope of this approach currently covers highly digitalised and customer facing businesses. The proposal assumes that extractive industry is carved out however the exact boundaries are still to be determined. For example, whether the carve-out would include all activities undertaken by an entity in the extractive industry, or only the extractive activities specifically.

The industry is seeking a carve-out from this approach, as it would have significant ramifications otherwise. For example, as documented in Rio Tinto’s publication, ‘Taxes paid: Our economic contribution 2018’, the company paid over $3 billion in corporate income tax in Australia and $5 million in corporate income tax in China, yet 56% of its sales revenue related to sales to China.

The Department of the Treasury have set up a working group, which is meeting in November to discuss the OECD’s strategic direction.

Pillars One and Two are expected to lead to a significant increase in global tax revenues. There is a risk that country-specific measures will be adopted, which could lead to disputes and inconsistencies.

Agenda item: 4 – Justified Trust update

The ATO is finishing phase 1 of the justified trust program and is looking at the next three years under the Tax Avoidance Taskforce extension.

Top 100 Program

The ATO is making changes to its Top 100 program. Taxpayers who achieve overall high assurance can expect to enter a maintenance and monitor phase of the justified trust program. The scope of reviews will be more targeted and less intensive. There will be a refresh in the third year, whereby another full justified trust review will be undertaken.

The interim findings on the justified trust program to date are expected to be published by the ATO in November 2019, subject to feedback being received. It will include insights on the Top 100 population as a whole, as well as on particular industries.

Based on current work plans, we expect that 70–71% of taxpayers will achieve high assurance by 2020.

Top 1000 Program

Approximately 700 Top 1000 reviews have been completed or are currently underway.

Risks identified from the Top 1000 program will be reviewed by Next Action teams. More resources are now being allocated to complete this work. Priority will be given to risks flagged to market and low assurance areas.

GST assurance programs

The ATO has been integrating GST into the Public Groups & International business line.

The primary issue in the large market in respect of GST relates to incorrect reporting. We are undertaking work to determine how we can help taxpayers test their systems and intend taxpayers to be able to test their own systems, rather than the ATO having to send teams out to do so.

Guidance will be released around where the ATO sees common mistakes. To increase transparency, details about how transaction testing is conducted by the ATO will also be released.

The ATO’s GST analytical tool is currently being piloted. The tool takes a top down approach and looks at the revenue and expenses in the statutory profit and loss statement and the relevant adjustments, and compares the adjusted revenue and expenses to the GST paid and claimed.

PRRT Reviews

At this stage, the ATO is not applying the full Justified Trust approach to the PRRT. However, reviews will start to incorporate the Justified Trust methodology.

Agenda item: 5 – Capitalised labour

The ATO has been considering the issue of capitalised labour for a number of years (first raised in the utilities industry) and recently determined that the development of a Taxation Ruling is necessary.

The draft Ruling was released for confidential consultation in May 2019 to a group consisting of the big 5 accounting/advisory bodies and other professional bodies. Twelve items of feedback were received, which have been considered in drafting the updated draft Ruling.

The feedback received concentrated around three main issues:

• not enough detail provided on the essential character test
• more explanation needed as to how and when to apportion
• more examples required.

Significant adjustments have been made to the draft Ruling. The ATO has a version which is close to being released as a draft to the public, which is expected in late October or early November 2019, within the next 4–6 weeks.

In addressing the feedback received, the ATO is mainly focusing on the essential character test and how to distinguish whether people are conducting work for the construction or creation of capital assets. The draft Ruling will consider whether the occurrence of work was specifically for the purpose of constructing or creating a capital asset – costs (whether wholly or in part) will be on capital account where you can establish this is the case.

The essential character test requires consideration of all relevant facts and circumstances (which can include the employment contract as well as the work actually performed). This will also include how a taxpayer treats labour costs for accounting purposes.

The ATO noted there may be some concerns around head office staff, like those in the legal, HR, finance departments, who may spend time on things related to the construction or creation of a capital asset. We consider that where the nexus is incidental or remote these employees are not specifically employed for the purpose of the construction or creation of a capital asset. Whereas a project team (including members in the legal, HR, finance departments) specifically employed to construct or create a capital asset would be considered to be on capital account.

The essential character test is considered at a point in time, so that the purpose of the expenditure/work can change. For example, someone can change from being specifically employed to construct or create a capital asset to being specifically employed to maintain that asset (including being directed to perform work completely different from their original contract of employment).

The previous version of the draft Ruling contained one example relating to the construction of an LNG plant. This will be maintained. The updated draft Ruling will contain four additional examples covering different circumstances, such as where the worker’s time is apportioned, where their time is sitting on the revenue account side and where their time is sitting on the capital account side. The examples will be contained in the Ruling.

At this stage, the ATO is not planning a separate guidance (such as a PCG). A single Ruling will be released.

The updated draft Ruling will contain more information on apportionment and reasonable methods, for example where employees are working on two different projects. The essential character of the work may be capital for part of the time. An example is in the utilities space where 60% of the employee’s time is spent on putting up capital assets such as poles and the other 40% is on maintenance. In these circumstances, it would be appropriate to apportion.

The ATO has not changed its view in regards to Steele.

There is no de minimis threshold in the draft Ruling.

The recent Sharpcan decision of the High Court gives a strong indication as to how to consider the capital/revenue distinction and contains a useful commentary of the revenue/capital principles.

Agenda item: 6 – Hybrid mismatch rules

The new hybrid mismatch rules came into effect on 1 January 2019.

The International Dealings Schedule and Reportable Tax Position now contain new questions in relation to whether the hybrid rules apply, including whether any restructures have occurred as a result of the hybrid rules coming into effect. The ATO wants to ensure that the replacement structure is not high risk and does not itself contravene any other rules.

The ATO is working to finalise LCR 2019/D1. Feedback was received during consultation and the final version is currently undergoing an internal approval process prior to finalisation.

LCR 2019/3, PCG 2019/6 and PCG 2018/7 have been released to date.

The ATO intends to release a draft Tax Determination regarding the interaction of the hybrid mismatch rules and the US’ Global Intangible Low-taxed Income rule.

The ATO is considering whether to release an omnibus ruling or determination on what constitutes a provision which corresponds to Australia’s hybrid or controlled foreign company rules.

The market is encouraged to engage with the ATO in relation to the application of the hybrid mismatch rules to any restructures, for example if the restructure does not fall into the low risk zone under the PCG, if there is uncertainty about which zone the restructure falls into, how the guidance applies.

We are working to implement the announced budgeted measures for the hybrid mismatch rules.

Agenda item: 7 – Thin capitalisation – arm’s length debt test

Draft TR 2019/D2 and PCG 2019/D3 were released in relation to the arm’s length debt test (ALDT). The consultation period on both products has closed and we are currently working through feedback and hope to finalise both products in the first quarter of 2020.

The ATO deliberated on how to identify key factors which need to be considered. This includes the meaning of ‘having regard’ to a particular factor as outlined in the guidance. If one ‘factor’ is negative or not supportive, it does not necessarily mean you fail the test.

The guidance provides that the factors do not have to be equally weighted. However if the taxpayer decides to weigh a particular factor higher or lower, the ATO will need to see evidence which supports that weighting.

The ALDT is not what amount of debt could possibly be sustained by the notional Australian business, but what amount of debt could be reasonably expected to be borrowed by or lent to the entity. It must be more than mere possibility, and be based on something more substantial.

PCG 2019/D3 outlines our suggested approach to the ALDT. It is not the mandated approach but will communicate what the ATO expects from taxpayers, what analysis will be undertaken by the ATO on the facts and circumstances, and how the ATO analyses transactions.

The ATO found significant divergence in the market on how the ALDT was applied and there was no consistency in the approach adopted. Our suggested approach to the ALDT is relatively prescriptive but will achieve consistency and reduce uncertainty in the market on how we will approach the test.

PCG 2019/D3 contains three low risk zones:

• Inward – This involves simple business activities, a simple structure, third party debt and no support by any related party.
• Outward – If the notional Australian business would have the same credit rating as the global group, we can conclude that there is no weighing of debt through or outside of Australia that would be concerning for the ATO.
• Regulated utilities – This market has a low risk gearing ratio

Agenda item: 8 – Intangible property migration

Intangibles arrangements are a key focus area for the ATO and compliance activity in this space will be increasing. The focus will be on:

• the dynamic migration of intangibles, rather than valuation. This includes looking at structured arrangements which avoid tax consequences upon the disposal of Australian generated intangible assets ;The avoidance of royalty withholding tax obligations
• claimed derivation of income from use of intangible assets in tax preferred jurisdictions as a result of mere legal ownership of intangible assets.

TA 2018/2 was released which is focused on embedded royalty arrangements, where an Australian entity pays for a tangible asset which includes the right to use intangible assets with the payment of a royalty.

The ATO is looking to release another Taxpayer Alert in 4–6 weeks, covering a number of intangibles arrangements. We intend to publish a PCG on intangibles migration which will be focused on communicating the ATO’s risk framework for intangible structures, highlighting high risk arrangements, and providing more detail about evidence the ATO expects to see (including functions, assets, and commercial drivers behind the transaction). The draft PCG is expected to be released in 2020.

Intangible property migration is not an issue which is more prevalent in any specific industry. The ATO is in discussions with private firms who are in the business of identifying intangibles, and is releasing guidance which encourages taxpayers to consider the documentation around their intangibles.

Agenda item: 9 – PRRT update – presented by the Treasury and ATO

Tranche 1 of the PRRT reforms has now come into effect.

The seven administrative measures for PRRT (Tranche 2) were expected to be progressed in 2019. Treasury would like to progress this as soon as possible, subject to Parliament’s time and the Government’s legislative priorities, however there is no date currently set.

A discussion paper has been released on the gas transfer pricing review, with non-confidential submissions available on the Treasury’s website. Targeted consultation with industry and industry participants is intended following internal deliberations within Treasury. Treasury’s final recommendation to Government will be provided by May 2020, as required under the Government’s request for review.

The PRRT gap released for the 2016–17 year was $22 million (2.1%).

The PRRT instalment forms have been updated. The annual PRRT returns will reflect the effect of the Tranche 1 reforms.

Agenda item: 10 – Other matters

The ATO is currently in the process of reaching out to participants of the Junior Minerals Exploration Incentive in respect of the 2017–18 income year to lodge their notification of issue or expiry of credits forms, which are due in October 2019.

Draft Schedule 3 to PCG 2017/4 is close to finalisation and intended to be published for draft consultation shortly. There has been difficulty in determining what certainty the ATO can provide taxpayers and how that will be done.

The ATO has looked at the Public Advice and Guidance work in progress, as we are pushing to remove the backlog. There were around 60 products and some have been removed from the list. Over 30 products were issued this year (in draft or final). There are 10 priority items the ATO would like to address this year.