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  • Key compliance risks for large corporate groups

    Given the complexity of their business structures and the law there will always be a non-compliance risk in the large corporate groups population. In the majority of cases this will be the result of a difference in the interpretation of the law or an error in applying it to their particular circumstances by a taxpayer. A small number of large corporate groups will choose to deliberately avoid their tax obligations.

    Our focus is on helping the majority who want to comply to do so and providing assurance their tax payments are correct. We do this through our one-to-one prevention activities and population-wide approaches.

    Where we do see deliberate attempts to avoid tax obligations we act decisively to address these arrangements.

    On this page:

    International risks

    Profit shifting

    Increased globalisation has brought many benefits, including increased economic growth, for countries. But it has also brought them new challenges – as a result of the increasing share of global gross domestic product and trade attributable to multinational enterprises.

    Companies no longer need to locate their operations close to customers or have fully integrated operations in a single location. Instead there is increasing centralisation of functions regionally or globally with supply chains dispersed across countries. The rise of the information and service economies, as well as advances in technology, have helped multinational enterprises to be able to place staff and operations in locations geographically distant from their customers. Some nations may also seek to attract investment by multinational enterprises by offering attractive tax rates and other incentives.

    These factors have also allowed for tax planning that takes advantage of arbitrage opportunities to minimise global tax payments. For some multinational enterprises, this tax planning goes beyond acceptable bounds. That's why we have an increasingly strong focus on global profit shifting.

    Related party debt

    A key corporate tax avoidance tactic is the excessive allocation of debt into Australian companies. This is sometimes described as debt dumping. The transfer pricing, thin capitalisation and general anti-avoidance rules may apply to these schemes.

    We're currently focusing on the more prevalent forms of related party debt risks. We have:

    • warned taxpayers and their advisers of high-risk arrangements through our taxpayer alerts
    • provided guidance to assist taxpayers self-assess the tax risk of their related party financing arrangement and our likely compliance approach given that risk profile
    • undertaken litigation in the most serious cases.

    An additional schedule to our practical compliance guideline (PCG) on related party financing arrangements, covering derivative arrangements, was finalised in November 2019. Another, outlining factors for determining if an interest-free loan is debt or equity in identifying the arm’s length conditions, is under development.

    We've also published:

    • a tax determination to assist taxpayers comply with the thin capitalisation rules on costs that are debt deductions for thin capitalisation purposes
    • a draft tax determination on valuation of debt capital and draft taxation ruling on the application of the arm’s length debt test
    • a draft PCG outlining our compliance approach to taxpayers who use the arm's length debt test.

    See also:

    • Recent cases
    • PCG 2017/4 ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions
    • TD 2019/12 Income tax: what type of costs are debt deductions within scope of subparagraph 820-40(1)(a)(iii) of the Income Tax Assessment Act 1997?
    • TR 2019/D2 Income tax: thin capitalisation – the arm’s length debt test
    • Draft TD 2018/D4 Income tax: thin capitalisation - valuation of debt capital for the purposes of Division 820
    • PCG 2019/D3 ATO compliance approach to the arm's length debt test
    • Advice under development – international issues – see item 3901

    Offshore service hubs

    Some multinational enterprises are using centralised operating models, often referred to as hubs, to undertake various activities. These arrangements are usually based on commercial considerations but sometimes the tax treatment may not be appropriate.

    We issued a taxpayer alert advising of our concerns with procurement hubs. We've also issued a practical compliance guideline to assist taxpayers to manage the risks and costs associated with hubs. Two schedules in the PCG cover marketing and procurement hubs.

    See also:

    • TA 2015/5 Arrangements involving offshore procurement hubs
    • PCG 2017/1 ATO compliance approach to transfer pricing issues related to centralised operating models involving procurement, marketing, sales and distribution functions

    Inbound supply chains

    Appropriate profit being recognised in Australia

    Many multinational businesses operate their Australian operations through subsidiaries. They use these to buy goods or services from their offshore parent or related companies, and on-sell to Australians.

    The key tax question is whether the price paid for those goods or services is an appropriate price under the law. Determining this can be particularly difficult when the goods or services have unique features. This can be hard even for taxpayers trying to do the right thing.

    Looking at the entire supply chain through a variety of lenses helps to determine if the pricing is giving sensible or distorted results. It can help clarify if the appropriate profit is being recognised in Australia.

    In March 2019, we published a PCG on transfer pricing issues related to inbound distribution arrangements, outlining our compliance approach. The PCG includes industry-specific schedules to provide more detailed guidance.

    Example: Australia inbound supply chains – determining if appropriate profits are recognised

    USA headquartered BrownGoodsCo is a worldwide electronic goods company. It undertakes significant research and development activities in its home jurisdiction. This is to develop new electronic goods and market its products. The worldwide profits of BrownGoodsCo are $12 billion on global sales of $60 billion. This gives an implied profit to sales ratio of 20%.

    BrownGoodsCo establishes a wholly owned subsidiary company, BGAus Ltd, in Australia. BGAus undertakes sales and distribution activities in Australia. It purchases the goods from offshore related parties located in low tax jurisdictions, and on-sells them. It also provides significant after-sales support in relation to its products.

    Sales of BrownGoodsCo products in Australia are $2 billion. After paying $1.8 billion for the products, BGAus has $105 million in other costs, mostly salary, leasing and similar. BGAus makes an accounting profit of $95 million on its business operations in Australia. BGAus reports these profits in its Australian income tax return.

    BGAus reports a taxable income of $100 million and pays income tax of $30 million. The difference to the accounting profit relates to employee-related expenses (such as annual leave and long service leave), which are only deductible when paid out.

    For accounting purposes, BGAus reports a tax expense of $28.5 million (an effective tax rate of 30%). It recognises a deferred tax benefit of $1.5 million for the deduction it will receive when it actually pays the leave costs.

    Overall, their tax expense is $30 million (or $28.5 million for accounts) against $2 billion in sales – this looks low at 1.5% of sales.

    The key tax issue is whether the $1.8 billion paid by BGAus to BrownGoodsCo for the goods is an appropriate arm's length price. In judging the risk of ‘transfer mispricing’, we will look at factors such as:

    • the margin on local costs – in this example the profit of $95 million on local costs of $105 million implies a relatively high return for the functions being performed in Australia
    • the profitability of the local operations compared with the entire supply chain. That is, BGAus is booking $95 million of profit as compared with an estimated whole of supply chain profit of $400 million (assuming Australian supply chain profit ratios align with global profitability). Given significant R&D and manufacturing offshore, booking 24% of profit for sales and distribution and after sales support appears reasonable
    • the implied commission on the goods – here, there is an implied commission of 10%, which appears reasonable for this industry
    • the motivation to transfer misprice – in this example there is a higher motivation to misprice, as significant profits are being booked in a low tax jurisdiction.

    Overall, the transfer price of the goods appears lower risk, and the tax payable in Australia appropriate. However, given the booking of significant profits in a low tax jurisdiction, we're likely to review the transfer pricing of BGAus.

    Note: The local effective tax rate of BGAus doesn't provide any guidance as to whether there is ‘transfer mispricing’, as any mispricing will affect its profit as well as the tax. On the other hand, simply focusing on cash tax versus gross sales won't reflect the degree of support provided by the Australian operations versus the rest of the global supply chain.

    End of example

    See also:

    • PCG 2019/1 Transfer pricing issues related to inbound distribution arrangements

    Artificially avoiding a taxable presence in Australia

    We've worked closely with taxpayers to ensure compliance with the MAAL. We responded swiftly and firmly when we identified some who were using high-risk arrangements in an attempt to avoid the operation of the MAAL. This included issuing three taxpayer alerts raising our concerns with these arrangements. We continue to monitor the environment and taxpayer arrangements to ensure continued compliance with the MAAL.

    See also:

    • TA 2016/2 Interim arrangements involving the Multinational Anti-Avoidance Law (MAAL)
    • TA 2016/8 GST implications of arrangements entered into in response to the Multinational Anti-Avoidance Law (MAAL)
    • TA 2016/11 Restructures in response to the Multinational Anti-Avoidance Law (MAAL) involving foreign partnerships

    Intangible assets and non-arm's length arrangements

    Intangible assets, including but not limited to intellectual property, are highly mobile assets. There are significant incentives to locate intangible assets in jurisdictions with favourable tax regimes.

    Tax benefits may be inappropriately obtained via the dynamic migration or artificial allocation of intangible assets, and rights in those assets, to offshore related parties. The risk is present due to non-arm’s length arrangements that:

    • migrate or artificially allocate Australian generated intangibles to offshore related parties
    • involve the use of intangible assets, particularly where the value of these assets is derived from or maintained by the activities of Australian entities
    • dispose of or allocate Australian generated intangible assets to offshore related parties and subsequently grant rights in these assets back to Australian entities.

    Intangible assets, particularly ‘hard to value’ intangibles, may have special or unique characteristics that complicate the search for comparable transactions and make market prices difficult to determine at the time of the transaction. OECD public guidance – in particular, BEPS Action 8: Implementation guidance on hard-to-value intangibles – should be considered.

    We've also issued a taxpayer alert advising taxpayers and their advisers to our concerns with arrangements that seek to avoid royalty withholding tax by mischaracterising or concealing intangible assets.

    Example: Transfers of intellectual property

    A foreign-owned Australian company (AusCo) holds internally generated patents that have not yet been commercialised. AusCo assigns the patents to a foreign subsidiary of its foreign parent (ForCo) for an amount less than the cost of development. ForCo then licenses the use of the patents back to AusCo.

    AusCo continues to carry out R&D activities in connection with the patents and enters into a contract (the contract) with ForCo. Under the contract:

    • AusCo’s R&D activities are treated as services provided by AusCo to ForCo
    • ForCo owns any patents or other intellectual property resulting from AusCo’s R&D activities.

    For Australian tax purposes, AusCo:

    • claims a capital loss from the assignment of the patents to ForCo
    • claims deductions for the licence fees payable by AusCo to ForCo under the licence back of the patents to AusCo
    • does not withhold royalty withholding tax on these licence fees
    • only returns the compensation for its activities payable by ForCo under the contract.

    We're concerned that:

    • the assignment of the patents by AusCo and their licence back were not arm’s length dealings
    • AusCo may not be returning adequate compensation from ForCo for  
      • the R&D activities it conducts under the contract for ForCo’s benefit
      • other activities it undertakes which preserve or develop the patents or other intellectual property
    • AusCo has incorrectly not withheld tax on its royalty payments
    • the amount of Australian tax paid by AusCo since the arrangement with ForCo was put in place is not commensurate with the economic activity undertaken by AusCo in Australia
    • the general anti-avoidance provisions may potentially apply.
    End of example

    See also:

    Outbound permanent establishments

    We're focusing on Australian income tax consolidated groups with certain outbound permanent establishment arrangements. These arrangements are structured to ignore intra-group transactions for Australian income tax purposes. Yet they're recognised by the offshore tax regime. We're concerned these arrangements may result in the under-reporting of income in Australia, incorrect deductions claimed here, and the double non-taxation of income.

    These types of arrangements are covered in specific provision of the hybrid mismatch rules. The new rules are specifically designed to counteract the effects of hybrid mismatches and ensure multinational groups don't gain unfair tax advantages over domestic groups.

    We've published guidance to assist taxpayers to comply with the new rules, including a law companion ruling and two practical compliance guidelines. We're also finalising a law companion ruling on the targeted integrity rule and considering further guidance on foreign law interactions with the hybrid mismatch rules.

    We'll work with impacted taxpayers with their transition to compliant arrangements.

    See also:

    Foreign resident disposal of Australian property

    We're concerned about foreign residents who obtain a tax benefit or avoid Australian tax obligations when they dispose of Australian property. We want to ensure asset classifications and valuations are consistent with legal requirements. For example, profits made from the sale of Australian real property (and related assets) should be taxed in Australia. Some schemes seek to shift or attribute value to non-land assets to escape taxation.

    Domestic risks

    Re-characterisation of income from trading enterprises

    We're concerned with arrangements that seek to divert and re-characterise business trading income into concessionally-taxed passive income flows. This may involve a single business being divided into separate enterprises. We've issued a taxpayer alert about our concerns.

    Legislative amendments have addressed some of these concerns by:

    • applying a 30% withholding tax on trading income converted to passive income via a stapled structure or distributed by a trading trust, and income from agricultural land and residential housing
    • amending the thin capitalisation rules to prevent foreign investors using double gearing structures to convert active business income to more favourably taxed interest income
    • limiting existing tax exemptions for foreign pension funds and sovereign wealth funds to passive income and portfolio investments only.

    We're currently finalising an LCR outlining how we'll administer the non-concessional managed investment trust income aspects of the legislation. We're also reviewing transitional election forms to ensure taxpayers electing to obtain transitional relief are entitled to that relief and complying with the legislation.

    The legislative amendments don't cover all of the arrangements we outlined in our taxpayer alert. We continue to look closely at these other types of arrangements and will take compliance action where we consider an arrangement poses a compliance risk.

    See also:

    Research and development

    The research and development (R&D) tax incentive program is administered jointly between AusIndustry and the ATO. As part of the co-administration, we've developed a joint risk strategy to cover particular activities of concern. These include claims attributing business-as-usual nature expenses to eligible R&D activities, and claiming R&D incentives for software development.

    We focus on incorrect claims in the building and construction, agriculture and mining industries. The strategy also highlights some R&D consultants as potential contributors to the risk.

    We've issued a number of taxpayer alerts, jointly with AusIndustry, outlining concerns with specific arrangements.

    See also:

    • TA 2017/2 Claiming the Research and Development Tax Incentive for construction activities
    • TA 2017/3 Claiming the Research and Development Tax Incentive for ordinary business activities
    • TA 2017/4 Claiming the Research and Development Tax Incentive for agricultural activities
    • TA 2017/5 Claiming the Research and Development Tax Incentive for software development activities

    Property and construction activities of large private groups

    Property and construction is a significant industry in the Australian economy. There has been strong growth in some property markets. Despite this, we've seen low tax performance and higher tax debts and insolvency rates than other industry segments. This has led us to take an industry-wide approach to risks in the segment for large private groups.

    See also:

    Group structuring and business events

    Significant business events attract our attention. These may be mergers and acquisitions, divestments of major assets and demergers, capital raisings and returns of capital. The structure of groups and changes that occur in those structures can present significant tax issues.

    See also:

    Combating corporate tax avoidance

    Tax Avoidance Taskforce

    We're resolutely tackling tax avoidance by multinational enterprises, large public and private groups, and highly wealthy individuals and their advisers. The government funding of the Tax Avoidance Taskforce provides more investment in this work to improve and expand our outcomes.

    See also:

    Recent cases

    A number of recent court cases reinforce our commitment to addressing tax avoidance and arrangements that seek to stretch the bounds of acceptable tax planning through the courts, where necessary.

    The Full Federal Court considered the application of transfer pricing rules to a cross-border related party financing arrangement in Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62. In this case the Court held an arm’s length rate of interest shouldn’t be determined as if the subsidiary were a standalone orphan company separate from the rest of the group. The decision has implications for other cases involving related party loans as well as other transfer pricing matters.

    In News Australia Holdings Pty Ltd v FCT [2017] FCA 645, the Federal Court considered an arrangement where News Limited subscribed for $460 million of redeemable preference shares in its wholly owned subsidiary incorporated in the Cayman Islands and borrowed $460 million from that subsidiary, at interest, to finance the subscription. The Court held the subsidiary, a controlled foreign company (CFC), derived interest income in the year ended 30 June 2010 not at a later time when the subsidiary had been disposed of and was no longer a CFC.

    Last modified: 13 Dec 2018QC 53317