Australia is relatively dependent on corporate income tax (TY2012: $64 billion of $298 billion total tax) compared to the other OECD countries, and the corporate income tax base is highly concentrated. In TY2012, 52% of total corporate income tax came from the financial services and mining sectors, and 41% of corporate income tax was paid by 20 companies.
We have high levels of foreign investment and our nominal net foreign direct investment (FDI) position was a $143 billion deficit in FY2012. This foreign investment has supported the Australian economy, with inbound FDI to GDP growing at a similar rate to the OECD average. This has made the Australian economy and its corporate tax base increasingly linked to foreign trade and investment.
Improvements in technology, reduced barriers to international trade, and the integration of developing economies into the global value chain have led to a fundamental change in how businesses operate. These developments challenge the existing global tax framework, which has been based on the physical transfer of merchandise goods and easily definable capital instruments. Today, a business can move its intangible and financial assets around the world and earn revenues from customers in countries where it has no physical presence. They also operate in an environment of increasing complexity, tax arbitrage opportunities, financial deregulation and corporate structuring.
Because business now has the ability to streamline value chains globally, companies are placing increasing emphasis on:
- centralising and transferring business activities, particularly service functions using digital platforms, and
- capitalising, sharing and transferring intangible assets to where their development and protection is most efficient.
Aligned with the growth of global supply chains, particular economies are attracting significant and increasing FDI relative to their economic output (GDP). They offer competitive business environments, targeted policy settings, including those that attract mobile capital, and relatively low corporate tax rates. We have termed these economies ‘hubs’.
The ATO is also addressing international tax concerns, including the migration of intangibles (IP) offshore, the creation of offshore marketing and procurement hubs, debt dumping arrangements and transfer pricing results which are inconsistent with arm's length outcomes.
The increasing international trade of mobile functions and assets is indicated by the high growth in net services and royalties credits into these hubs. Net services and royalties credits to GDP were between 3% and 5% in CY2012. This is also reflected in high levels of international related party services and royalties trade between Australia and these hubs. In CY2012:
- ABS figures totalled $110 billion for trade in services and royalties
- revenue and expenditure shown in tax returns for international related party dealings in royalties and services totalled $67 billion
- 27% ($18 billion) of international related party services and royalties reported to the ATO was with hub economies.
Australia has comparatively strong transfer pricing, general anti-avoidance, thin capitalisation and controlled foreign corporation rules that provide defences against BEPS risks. This places pressure on particular tax mechanisms, such as transfer pricing and permanent establishments that have been designed to support the concept of fair global tax distribution and minimise double taxation. The OECD Base Erosion & Profit Shifting ('BEPS') Action Plan highlights many of these issues.
The OECD’s Action Plan on BEPS focuses on areas where the existing international tax framework lags behind the global evolution of MNEs’ business operations. Existing data and studies do not provide enough information to reach definitive conclusions about how much BEPS actually occurs.
Corporate income tax in Australia
Corporate income tax is a large contributor to the Australian tax base, accounting for $64 billion (22%) of Australia’s total tax base of $298 billion in TY2012 (Figure 1). Because $18 billion of the $64 billion in company tax is claimed back by resident shareholders under the dividend imputation system, the adjusted proportion falls to 15% (see Appendix B). While smaller, this contribution to the Australian revenue base is still much higher than the OECD simple average of about 9%1
The relatively large contribution of corporate income tax is linked to Australia’s higher corporate headline tax rate (30%) relative to the OECD simple average for small and medium sized economies (25%). It reflects our policy choice to rely more on corporate profits rather than corporate taxes on employee social security contributions and other indirect taxes.
Source: Taxation Statistics 2011-12
Given the relative importance of corporate income tax for our revenue base, understanding and monitoring the impacts of BEPS is important for Australia.
Total corporate income tax grew from $31 billion in TY2003 to $64 billion in TY2012, whilst GDP increased by 85%, reflecting greater company profitability. The corporate tax base is highly concentrated: the largest 20 companies accounted for more than 40% of total corporate income tax paid in TY2012.The financial services sector is the biggest contributor to corporate income tax (TY2012: $18 billion), while the mining sector is second, paying $15 billion 2 (Figure 2).
Growth in mining sector tax payments was driven by high commodity prices peaking in November 2008 and June 2011. Mining growth in this period partially offset declining tax from the financial services sector resulting from the GFC.
Since TY2009 the trend in corporate income tax from the financial services and mining sectors has been volatile. This reflects changing industry conditions, the tax performance of a few key taxpayers and the use of carried forward losses and other tax items 3.
Source: Taxation Statistics 2003-12.
Australia in a global world
Increasingly interconnected with the world
Australia has become increasingly interconnected with the global economy (Figure 3). Since FY2005, total ABS figures for commercial trade in goods and services 4 (FY2012: $590 billion) have grown faster than GDP. Merchandise trade made up 81% of Australia’s international trade in FY2012, of which 42% was metal ore or fuel commodities. International trade in services (including royalties) was $110 billion or 19% of total international trade.
Tax revenue and expenditure for international related party dealings (IRPD) in tangible property, services and royalties/licence fees totalled $273 billion in TY2012). Revenue and expenditure for IRPDs in tangible property of a revenue nature (such as stock in trade) accounts for 70% of total revenue and expenditure for IRPDs. Most is returned by the mining, motor vehicle, and machinery and equipment industries.
From FY2005 to FY2012, total ABS figures for international trade in services grew by 42%, for royalties by 49%, and for goods by 79%. In contrast, total tax revenue and expenditure for international related party dealings in tangible goods grew by 53%, in royalties/licence fees by 96%, 5 and in services by 133%. While the existence of international related party dealings does not represent tax avoidance in and of itself, the growth rate differentials highlight our focus on addressing BEPS.
Source: ABS: series 5368.2 International trade in goods and services, 5206.33 Industry gross value added; ATO: International Dealings Schedule (IDS), Financial Services (FS) IDS and Schedule 25A.
Economic growth driven by financial services and mining
The Australian economy has performed well over the past decade. Our position as a major global supplier of mineral commodities has been a major factor in our comparatively strong economic performance. In nominal terms, GDP increased from $800 billion in FY2003 to $1.49 trillion in FY2012 (real value: $1.14 trillion).
Gross value added (GVA) measures (Figure 4) show:
- Australia’s domestic economy is based on services which account for two-thirds of total GVA, similar to the rest of the OECD weighted average of 67%
- before the global financial crisis took full effect in FY2009, the financial services sector grew strongly
- the mining sector grew rapidly from FY2004, driven by high demand, particularly from China, and
- the manufacturing sector has remained stagnant.
Source: ABS series 5220.10 Australian National Accounts – Expenditure, Income and Industry Components of GDP, current prices.
Australia is dependent on foreign capital
Since FY2005, our gross direct investment position (FY2012: $1 trillion) has grown faster than GDP, and direct debt investments into Australia have recently grown faster than direct equity investments into Australia. This debt balance remains less than half of that of direct equity investments (Figure 5). Direct capital imports have grown from a net deficit position of $64 billion in FY1993 to a $143 billion deficit in FY2012.
Source: ABS: 5302.0 Balance of Payments and International Investment Position, Australia
Interest-bearing debt from international related parties totalling $372 billion was reported to the ATO in TY2012. This number, while higher than in the FDI data 6, is about 20% of total debt reported in company income tax returns. International related party interest expenses (TY2012: $16 billion) account for half of all interest expenses paid overseas, as reported in income tax returns.
Australia has thin capitalisation, transfer pricing and general anti-avoidance rules which mitigate these risks. However, the continued growth in Australia’s capital imports heightens the focus on issues such as debt push downs and excessive interest arrangements, as well as tax arbitrage via hybrid entities or instruments. These are included in the OECD’s Action Plan to address BEPS under Action Item 2 (neutralise hybrid mismatch arrangements) and Action Item 4 (limit base erosion by interest deductions and other financial payments).
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.
Source: World Bank
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.
Source: World Bank
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.
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.
Source: World Bank
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.
The selected measures reflect the increasingly globalised trade and investment flows that underpin Australia’s economy. While we have strong commodities exports, we are a net services importer and do not earn significant royalty income from abroad.
Large amounts of FDI (relative to GDP) are flowing into hubs which receive significant services and royalties income, suggesting they are a more favourable location for MNEs to place particular functions, assets and risks. From Australia’s perspective, the increased intra-group trade with hub economies is important because MNEs operating in Australia increasingly rely on commercial services or the right to use intangible assets from offshore related entities as part of their global value chain. In TY2012, approximately 27% ($18 billion) of Australian international related party services and royalties traded was with one of the hub economies.
Australia has comparatively strong transfer pricing, general anti-avoidance, thin capitalisation and controlled foreign corporation rules that provide defences against BEPS risks. Given that Australia is dependent on corporate income tax revenue more than most other OECD economies, and the overall tax performance of a few companies can significantly affect the performance of the corporate tax base, we are focused on monitoring and understanding BEPS trends at both the taxpayer and tax system level. The results provide evidence to support the consideration of whether law reform is necessary domestically by Treasury, and internationally by the OECD Working Parties to the Action Plans.
Appendix A: Data sources and details
This report primarily uses World Bank, Australian Bureau of Statistics National Accounts, TaxStats and internal ATO data. The data released by the World Bank was chosen because it provides the most comprehensive coverage across countries, including the low-tax jurisdictions and the key Asian economies. It has been cross-checked against our operational intelligence. Figures in this report are represented in nominal Australian dollar terms and are compared with GDP to reflect relative trends over time, particularly for cross-country comparisons. Measures of corporate profit, such as gross operating surplus, have not been used because some countries do not report this measure. Results may differ, depending on the data extraction date. The impact of these differences is unlikely to be material.
Figures from 2012 were used because they reflected the final year of data available at the time of writing. Ten-year time series data is from 2003 to 2012, while data associated with international related party dealings and international trade in services and royalties is presented from 2005 to 2012, due to data limitations in previous years.
Depending on the data sources figures are presented in income tax years (TY), financial years (FY) or calendar years (CY). In this report, the reporting period is specified in front of the year for each observation – for example, financial year 2012 is represented as FY2012 9. Australia reports national accounts (GDP, GVA etc.) on a FY basis, while the rest of the world mostly reports on a CY basis. As a result, FY figures are sometimes compared to CY figures from other countries. These differences do not affect the overarching trends, due to the relative length of the time series. TY figures are required, due to companies with substituted account periods (SAP) that differ from the financial year 10.
Appendix B: Imputation system
Through Australia’s dividend imputation system, approximately $18 billion of company income tax is passed on to the benefit of shareholders. This portion of company tax is, in effect, a pre-payment of individual/superannuation fund tax. For this analysis, franking credits have been separated out to make Australia’s corporate tax base more comparable to other countries without franking regimes.
Asian service hubs
Asian service hubs include Singapore and Hong Kong.
Commercial services are defined by the IMF’s Balance of Payments Manual (sixth edition)External Link. For the purposes of the analysis in this report services trade reflects commercial services trade only.
European IP hubs
European IP hubs include Ireland, Netherlands, Switzerland and Luxembourg.
Foreign direct investment (FDI)
FDI is defined in the IMF’s Balance of Payments Manual (sixth edition). It reflects net inflows of investment to acquire a lasting management interest (10% or more of voting stock). It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. The impact of foreign exchange and interest rates on this analysis is limited. For further information on foreign exchange impacts on Australia’s international investment position, refer to RBA, Foreign currency exposure and hedging in Australia, December 2013External Link
Gross value added (GVA)
GVA is used to measure the contribution to GDP at an industry level. Broadly, GVA represents payments to employees and company profits.
Non-financial services industries
Non-financial services industries include wholesale, retail, accommodation/food services, transport/postal services, information/media/telecommunication services, rental/hiring/real estate services, professional/scientific/technical services, administrative/support services, government services, education services, healthcare services and arts/recreational/all other services.
Research and development (R&D)
R&D expenditure represents all current and capital expenditures (both public and private) on creative work undertaken systematically to increase knowledge
As per the International Dealings Schedule Instructions. These include Aruba, the Bahamas, Belize, Bermuda, Dominica, Grenada, Liberia, Mauritius, Panama, Samoa, Seychelles, St. Kitts and Nevis, St. Lucia, St. Vincent, the Grenadines and Vanuatu.
At times, national accounts figures were not available for some countries. In these circumstances, some countries were excluded or have had previous-year data applied to the missing data point. Results should be interpreted with some caution.
Total international related party debt
Total international related party debt includes interest-bearing and interest-free debt.
Total tax revenue
The World BankExternal Link defines total tax revenue as: compulsory transfers to the central government for public purposes. Certain compulsory transfers, such as fines, penalties, and most social security contributions, are excluded.
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World Development Indicators. (2014). Retrieved 2014, from World DataBank: https://data.worldbank.org/products/wdi#archives1 CY2012 simple average across OECD members excluding Australia. No data available for Japan, Greece and Poland. Corporate tax on profit and capital gains to total tax based off OECD Revenue Statistics, https://stats.oecd.org/Index.aspx?DataSetCode=REVExternal Link. Values from this series for Australia differ from Tax Stats because of conceptual and timing differences. For more information on OECD revenue statistics see, OECD, Revenue Statistics 2013.2 This increase may be skewed upwards as a number of companies were misclassified during the early 2000s3 These items refer to tax depreciation on significant capital investments, the offshore banking unit regime and non-assessable non-exempt income items such as 23AH branch, 23AI controlled foreign corporation and 23AJ dividend income.4 Sum of ABS figures for trade in:(a) material goods entering (imports) or leaving (exports) Australia, excluding international trade in non-monetary gold and coins, and government goods and services(b) services rendered by Australian residents to non-residents (credits) and by non-residents to residents (debits).5 International related party royalty expenses have increased as a share of total royalty expenses paid overseas using data from company income tax return and associated schedules.6 International related party debt is far greater than foreign direct debt investment in Australia because the former is a construct of tax law and accounting principles while the latter is a construct of the National Accounts. Differences exist in the treatments of debt like hybrid instruments and the treatment of loans between related party financial institutions. Other differences are explained in OECD, Foreign Direct Investment for Development, 2002, https://www.oecd.org/investment/investmentfordevelopment/1959815.pdfExternal Link7 Country comparisons are made on a weighted average basis to be more representative of the larger economies in the group.8. In TY2012, the aggregated company income tax return data for royalty expenses paid overseas were $6.4 billion while total international related party royalty expenses and licence fees were $6.2 billion9 For more information on balancing periods see the World Bank Help Desk https://datahelpdesk.worldbank.org/knowledgebase/articles/201203-is-all-the-wdi-data-based-on-calendar-year-or-fiscExternal Link; World Bank, World Development Indicators, Primary data documentation notes, 2013, https://data.worldbank.org/products/wdi#archivesExternal Link; ATO, Taxation Statistics, Frequently Asked Questions, https://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Tax-statistics/Taxation-statistics---FAQs/#Q410 For more information on the difference between tax and financial years see - ATO, PS LA 2007/21 Substituted Accounting Periods (SAPs), https://law.ato.gov.au/atolaw/view.htm?Docid=PSR/PS200721/NAT/ATO/00001Report on the extent of Australia's international trade, various tax concerns and how we are addressing those issues.