• Australia in context

    This section uses World Bank data to compare Australia’s economic performance against selected economies 7. These are Asian ‘service hubs’ (Singapore and Hong Kong), European ‘intellectual property (IP) hubs’ (the Netherlands, Ireland, Luxembourg and Switzerland), the OECD (excluding Australia and the European IP hubs) and specified countries, including Bermuda, the Bahamas, Seychelles, Panama and Vanuatu.

    The hub economies have been identified since they offer more streamlined business processes, less regulation and less complex tax/lower tax regimes compared with Australia and most other OECD members. They are attractive locations for businesses to develop their regional headquarters and/or undertake centralised functions, and have been grouped because they share these attributes.

    Investment trends globally

    The pattern of cumulative inbound FDI into Australia generally aligns with the level of our economic activity (GDP) and is similar to the OECD weighted average (Figure 6, below). Over the past decade, large amounts of capital investment have flowed into Asian service hubs (Singapore and Hong Kong) and the European IP hubs (Ireland, Switzerland, the Netherlands and Luxembourg).

    These countries are increasingly attracting:

    • functions that can easily be centralised, such as marketing and procurement
    • the development and protection of highly mobile assets, such as brand value and IP
    • consolidation and ownership of risks that were previously shared across multiple entities.

    The hubs’ total tax revenue relative to GDP is similar to the OECD weighted average (Figure 6, below). However, the composition of their base is different. These economies tax different components of their economy, such as salary and wages, or VAT, at a higher rate, and offer a more competitive corporate tax environment.

     The chart shows that the Asian and European service hubs have been receiving greater amounts of FDI relative to their GDP at a faster rate than Australia and the rest of the OECD countries since 2003.

    Source: World Bank

     The chart depicting total tax revenue to GDP shows that Australia’s total tax revenue to GDP have been dropping while the Asian service hubs has increased since 2003.

    Source: World Bank

    Trends in services trade

    While Australia has a strong services base, it is not a net exporter of commercial services. Since CY2005, Australia’s net services international trade balance has declined (Figure 7, below) and, in CY2012, Australia had a net services trade deficit of almost $12 billion (1% of GDP). During the same period, other OECD members maintained relatively stable trade surpluses in services.

    Meanwhile, Asian service hubs have increased international services trade growth, shifting from a net services trade deficit in CY2005 to trade surplus. In CY2012, international net services trade for the Asian service hubs accounted for almost 5% of their GDP. For these economies, services account for almost 80% of their economic value-add.

    The SVA to GDP chart shows that for the Asian service hubs, services account for 85% of their GDP, this is in comparison to around 65% for Australia, showing that services is an important contribution to their economy. This proportion has been steady since 2003.

    Source: World Bank

     The international commercial services trade contribution to GDP chart shows that Australia has a negative contribution; this is in comparison to the other OCED countries and the European and Asian service hubs that have a net positive contribution. Since 2003 the Asian service hubs have turned their -7% contribution to a positive 5% reflecting the growing important of services to their economy.

    Source: World Bank

    Total revenue and expenditure for international related party dealings in services and royalties/licence fees has more than doubled since CY2005, reaching $67 billion in CY2012 – 27% of this is with an economic hub.

    The increase in international related party services transactions (Figure 3) and Australia’s growing services trade deficit emphasise our focus on tax risks, such as:

    • services provided offshore to related parties may be characterised and/or priced incorrectly according to arm’s length principles
    • subsidiaries of Australian companies being compensated solely for routine or contract R&D services, compounded by sales from Australian customers not being assessable in Australia.

    These issues have been identified in Action Item 1 (addressing the tax challenges of the digital economy and associated draft discussion) and Action Items 8 through to 10 (assure transfer pricing outcome are in line with value creation) in the OECD’s Action Plan to on BEPS. These issues create challenges for tax administrators; however, Australia has strong defences via its transfer pricing, general anti-avoidance, and controlled foreign corporation rules.

    Intangible assets

    At an aggregate level, R&D is a useful indicator to identify the development of intangible assets. Australia has a similar R&D to GDP profile (CY2012: 2.4%) relative to other OECD members.

    While intangible assets are difficult to detect and value, royalty payments charged for the right to use an intangible asset provide an indication as to where significant intellectual property assets may be located (Figure 8, below).

    Large and increasing payments into the European hubs are observed – all of which have implemented government policies to attract IP to their jurisdictions. The OECD, particularly the US and Japan, also attracts significant royalty revenues. These are mainly derived from their technology, pharmaceutical and entertainment industries.

    In contrast, Australia lags behind the rest of the OECD in terms of generating revenue from charging royalties for the use of Australian-based intellectual property assets. Growing amounts of expenditures are shown in tax returns for royalties or licence fees to international related parties. This expenditure represents almost 100% of total royalties paid overseas shown in tax returns 8. Revenue and expenditure shown for international related party royalties totalled $7.2 billion in TY2012. Of this, $1.3 billion was traded with related parties in hub countries in TY2012.

     The R&D expenditure to GDP comparison shows that Australia, the OCED member countries and the European IP hubs have the highest ratio at around 2.3% of GDP. This is in comparison to the Asian services hubs at 1.4% and the specified countries at 0.2%.

    Source: World Bank

     Although Australia has one of the highest levels of R&D expenditures to GDP, its level of royalty income has steadily dropped over the years. This is in comparison to the European IP hubs, the Asian service hubs and the OCED members who have experienced a growing level of royalty income to GDP.

    Source: World Bank

    Intangible assets and their associated transactions present challenges for tax administrators because these types of assets are characterised as attracting high returns in the MNE global value chain, are inherently very difficult to value correctly and can be shifted between countries. These issues are covered under Action Item 8 and the associated discussion draft on transfer pricing aspect of intangibles.

      Last modified: 13 Jan 2015QC 43707