Multinationals and tax transparency

As expected, a centrepiece of the Government’s tax agenda in this October 2022 Budget is its proposed multinational tax integrity and enhanced tax transparency measures, which were first announced as part of the Government’s 2022 election commitment platform. These are some of the most significant and wide-reaching tax integrity measures seen for many years and will require careful consideration by any taxpayer that engages in cross-border activity and investment.

In summary, the Budget confirms that the following changes will be implemented:

Australia’s existing thin capitalisation rules will be amended to limit debt-related deductions for multinational enterprises (MNEs) to 30 per cent of Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA) (i.e. an earnings based ‘safe harbour’ test) in line with the Organisation for Economic Cooperation and Development (OECD)’s recommended approach under Action 4 of the Base Erosion and Profit Shifting (BEPS) Action Plan
a new rule to limit certain MNEs' ability to claim tax deductions for cross-border payments relating to intangibles that lead to insufficient tax paid outside of Australia, and
enhanced tax transparency obligations for certain entities and tenderers for Australian Government contracts.

In August 2022, Treasury released a Discussion Paper seeking views on a range of issues relating to the implementation of the majority of these measures. This discussion paper raised a number of critical questions relating to the design of these measures, some of which have now been answered.

Although this Budget did not reference Australia’s implementation of the OECD two-pillar solution to address the tax challenges of the digitalisation of the economy - i.e. the Pillar One and Pillar Two reforms - this remains on the Government’s multinational tax reform agenda as it continues to participate in the OECD design process and Treasury progresses its consultation on the practical implementation issues.

Unfortunately, there has been no mention in this Budget as to whether the Government intends to proceed with the previously announced reforms to the corporate tax residency definition. This remains an area of ongoing uncertainty, with the Australian Taxation Office’s (ATO) transitional compliance approach expiring on 31 December 2022.

New interest limitation rules

The announced change to Australia’s thin capitalisation rules to shift from the current asset based safe harbour test to an earnings based safe harbour is a significant change for multinationals.

In some respects, the August 2022 Discussion Paper released by the Treasury raised more questions than it did provide answers, so it is pleasing to see some additional details released as part of this Budget to assist taxpayers prepare for the changes which were confirmed to apply to income years commencing on or after 1 July 2023.

With only eight months to go until the proposed earliest start date, there is a lot of work yet to be done to get these measures through Parliament and for taxpayers to prepare for implementation. We would hope to see draft legislation released for consultation in the weeks ahead, with the measures introduced into Parliament before the end of the year or early next year.

Some of the key areas that have now been clarified include:

The Government has confirmed that taxpayers will be able to carry forward any disallowed interest deductions for up to 15 years. PwC advocated for a carry forward feature in its submission on the Discussion Paper, as it addresses the impact of earnings volatility on EBITDA and ensures that long-term capital projects are not at risk of a permanent denial of interest deductions.
The existing worldwide gearing test will be replaced with a new earnings based group-ratio rule. This will allow an entity in a group to claim debt-related deductions up to the level of the worldwide group’s net interest expense as a share of earnings, where that exceeds the 30 per cent EBITDA ratio on a stand alone basis.
Whilst the Budget confirmed that the arm's length debt test will remain, it does indicate that this will only be available for external (third party) debt. This is an unexpected change that will significantly restrict its availability and impact a number of taxpayers with commercial capital structures that include related party debt. This is good news, however, for taxpayers that can genuinely support higher levels of debt and have raised all of their Australian debt directly from third parties.
These changes will apply to multinational entities operating in Australia and any inward or outward investor, in line with the scope of the existing thin capitalisation regime. Financial entities and authorised deposit taking institutions (ADIs) remain carved out of these changes, as originally announced.

With the proposed start date for these measures set for income years commencing on or after 1 July 2023, it is disappointing that there is no indication of any transitional rules, and still a number of questions outstanding. For example, there is still no confirmation as to whether EBITDA will be based on tax or accounting concepts, if any conditions will be imposed on disallowed interest deductions carried forward, and how the worldwide group will be defined for the purposes of the group ratio test.

For impacted taxpayers, preparing early and engaging stakeholders will be critical. With the additional details now available, taxpayers can review existing arrangements, model the impact of the proposed changes based on certain assumptions, and consider whether changes may be required to their existing capital structure.

Limiting deductions for payments relating to intangibles

The treatment of deductions for payments relating to intangibles has been a focus area of the Australian Taxation Office (ATO) for some time, and this new proposal is the latest measure to specifically target these types of payments. The Government is proposing a specific new anti-avoidance rule to deny deductions for Significant Global Entities (SGEs) for payments made directly or indirectly to a related party in relation to intangibles held in a low or no-tax jurisdiction.

The measure will apply to payments made on or after 1 July 2023.

For the purpose of this new rule, a low or no-tax jurisdiction is a jurisdiction with:

A tax rate of less than 15 per cent, or
A tax preferential patent box regime without sufficient economic substance.

No further details have been provided but with a commencement date of 1 July 2023, we would hope to see draft law in the coming months.

As far back as 2019, the current Government, when then in opposition, explained that any reforms in this area will be combined with a ‘dominant purpose’ test so that the measure is targeted for the integrity of the tax system. The October 2022 Budget information does not refer to “purpose”, which means the scope of payments potentially caught by the measure is broad.

These proposed new rules will also need to be considered in the context of their interaction with Australia’s existing integrity measures, including the transfer pricing rules, general anti-avoidance provisions, the Multinational Anti-Avoidance Law (MAAL), the Diverted Profits Tax (DPT), principal purpose tests (or similar rules) in Australia’s bilateral tax treaties and the controlled foreign company (CFC) rules, and the OECD’s proposed Pillar Two rules.

Taxpayers affected by these new rules will likely need to review their existing intangibles arrangements and the potential after-tax cost of any payments. Combined with the cost of withholding taxes which are imposed on cross-border royalties, a denial of an Australian tax deduction for payments within scope of this measure can cause a significant financial impact. This may also mean that some Australian businesses review their current and proposed business models in Australia in order to evaluate the impact of this upcoming measure.

Enhanced tax transparency

A number of measures were confirmed in the Budget that aim to improve the public tax transparency of taxpayers. These will supplement the existing rules which deal with transparency in relation to the tax affairs of the largest of Australia’s taxpayers.

The new Parliament has already legislated in recent months an expansion of the number of companies for which the Commissioner of Taxation annually reports in a Corporate Tax Transparency report outlining taxpayer details on total income, taxable income and tax payable. Specifically, with effect from the 2022-23 income year, all companies (whether public or private, domestic or foreign owned) are subject to this reporting where they have total income of at least AUD 100 million.

The following additional measures which aim to improve the public tax transparency of taxpayers were confirmed in the Budget to apply to income years commencing from 1 July 2023:

SGEs, including entities that may not be subject to the country-by-country reporting requirements, to prepare for public release of certain tax information on a country-by-country basis and a statement on their approach to taxation, for disclosure by the ATO
Australian public companies (both listed and unlisted) to disclose information on the number of subsidiaries and their country of tax domicile, and
Tenderers for Australian Government contracts worth more than AUD 200,000 to disclose their country of tax domicile by supplying their ultimate head entity’s country of tax residence.

No further details of how these measures will apply were provided. Accordingly, there remains a lot of outstanding questions, particularly in relation to exactly what needs to be reported, as well as the form and timeframe for reporting.

Global work continues on OECD Pillar One and Two

With the release of a Treasury consultation paper on the implementation of the OECD’s Pillar One and Pillar Two work in early October 2022 for comment by 2 November 2022, it is no surprise that these measures did not feature in this updated 2022-23 Federal Budget.

As a reminder, in 2021 Australia and over 130 other countries endorsed a proposal to reform the international tax rules to address the challenges arising from the digitalisation of the economy. This work, developed by the OECD Inclusive Framework on Base Erosion and Profit Shifting, proposes a two-pillar approach to addressing these challenges, as follows:

‘Pillar One’ reallocates some of the taxing rights over the largest and most profitable multinationals to the countries where their goods and services are consumed (‘market jurisdictions’). The amount of taxing rights to be redistributed under Pillar One is known as ‘Amount A’. This redistribution would only apply where a multinational has global revenues exceeding EUR20 billion per annum and also has a profit-before-tax to revenue ratio exceeding 10 per cent. Critical aspects of Pillar One are still being negotiated at the international forum, resulting in a delay in the proposed implementation timeframe to 2024.
‘Pillar Two’ puts a floor on global tax competition by including new taxing rights over undertaxed profits of entities within a multinational group with global revenue of at least EUR750 million per annum which are taxed below the globally agreed minimum tax rate of 15 per cent. Pillar Two consists of the Global anti-Base Erosion (GloBE) Rules and the Subject to tax rule (STTR). The OECD has released the Pillar Two model rules that set out the structure of Pillar Two along with additional technical guidance on their operation. An Implementation Framework is due to be completed by the end of 2022 to support domestic implementation and administration of the model rules. The OECD implementation plan envisages that Pillar Two will take effect in 2023.

The consultation paper released earlier this month raised a number of questions regarding implementation of these rules in Australia, including interactions with the existing corporate tax system, ways to minimise compliance costs, and the potential implementation of a domestic minimum tax to complement Pillar Two.

The paper indicated that Australia will continue to work with the OECD to finalise the outstanding details of the two-pillar solution and work towards implementation with further consultation necessary to assess the impacts and various implementation options available. We expect that the 2023-24 Federal Budget to be delivered next year will make reference to the implementation of the measures in Australia, including their commencement.

Multinationals and tax transparency

- 2 items

Federal Budget | Tax

Quarterly Tax Briefing | Federal Budget Special

New interest limitation rules

Limiting deductions for payments relating to intangibles

Enhanced tax transparency

Global work continues on OECD Pillar One and Two

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