29 June 2022
In Brief
On 29 June 2022, the Australian Taxation Office (ATO) issued its finalised guidance in the form of Taxation Determination TD 2022/9 (the TD) in relation to the hybrid mismatch rules and the United States (US) “GILTI” rules which, in essence, include certain income of controlled foreign companies (CFCs) in the US tax base. The TD is the finalisation of TD 2019/D12 (Draft TD) which was issued more than two and a half years ago.
In short, the Commissioner of Taxation (Commissioner) considers that the US taxation of payments as a result of the application of the GILTI regime does not mean that an amount is “subject to foreign tax” because the GILTI regime does not “correspond” to Australia’s CFC rules. In essence, this is because GILTI is a minimum tax regime and the Australian CFC rules have a different purpose. The CFC test is only one limb of the “subject to foreign tax” test and the formal (i.e. binding) part of the TD does not address whether a GILTI inclusion generates an amount being “subject to foreign tax” under the “basic” test.
This means that under the hybrid mismatch rules, Australian taxpayers could be denied deductions for certain payments, notwithstanding those payments are included in the tax base of a US taxpayer (unless it falls within another limb of the “subject to foreign tax” test). In addition, where an Australian entity’s income is subject to US federal income tax under the GILTI rules, these amounts would not be considered “dual inclusion income”, notwithstanding those amounts are also included in the tax base of a US taxpayer. This is an important issue for many US headquartered multinational groups as the Commissioner’s interpretation ultimately can result in double taxation outcomes.
While the conclusion in the TD has not changed from the Draft TD, the Commissioner’s reasons for reaching this conclusion have substantially changed and this may inform the approach likely to be adopted by the Commissioner in other areas of the hybrid mismatch rules.
In Detail
Very broadly, the hybrid mismatch rules provide that an amount should be viewed as “subject to foreign tax” to the extent it is subject to “ordinary” foreign taxation or taxation because of a foreign country’s CFC regime. In this regard, the legislation (subsection 832-130(5) of the Income Tax Assessment Act 1997 (ITAA 1997)) provides that:
An amount of income or profits of an entity is subject to foreign income tax if the amount is included in working out the tax base of another entity under a provision of a law of a foreign country that corresponds to section 456 or 457 of the Income Tax Assessment Act 1936 (including a tax base that is nil, or a negative amount).
The concept of “subject to foreign tax” is relevant for working out whether a “deduction/non-inclusion” outcome arises in respect of a payment (which could result in a denied deduction) and in determining whether a taxpayer has sufficient “dual inclusion income” (which can reduce the adverse impacts of certain hybrid mismatches). The “subject to foreign tax” concept is also relevant for the purposes of the unique Australian low tax lender rule which can apply where interest and certain other similar payments are subject to foreign tax at a rate of 10% or less and certain other conditions are satisfied. The “subject to foreign tax” concept may also be relevant in considering the operation of particular hybrid mismatch rules (for example, the existence of a hybrid payer mismatch).
The TD considers only whether section 951A of the US Internal Revenue Code (commonly referred to as the GILTI or global intangible low-taxed income rule) is a provision of a law of a foreign country that “corresponds to” Australia’s CFC provisions for the purpose of subsection 832-130(5) of the ITAA 1997.
The draft TD took a mechanical approach of examining features of the GILTI calculation and concluding that there were “notable” differences between the GILTI rules and Australia’s CFC rules. Having regard to these differences, it was concluded that the GILTI regime did not correspond to the Australian CFC regime.
The TD concludes that there are “substantive” differences but takes a different approach to the statutory question. Instead of focusing on the mechanics of how GILTI is calculated, the TD explains that it is necessary to consider the features of the foreign law and its statutory object and purpose. The question of correspondence does not focus on detail but rather the “gist” being the substance of GILTI or its essential parts and it is not necessary to focus on the “mere mechanics” of the foreign law.
According to the TD, the purpose of the GILTI regime differs from the purpose of the Australian CFC regime. At its core, the objective of the GILTI regime is to impose a minimum rate of tax on deemed high or above‑normal returns of CFCs. In contrast, the Australian CFC regime is not a minimum tax regime. The purpose of sections 456 and 457 of the Income Tax Assessment Act 1936 (ITAA 1936) is to deter tainted income from being shifted offshore with the aim of avoiding or deferring Australian tax. In short, the “gist” or substance of the GILTI regime (including a number of elements of the US law making up the overall regime) is not the same as the “gist” or substance of the Australian CFC regime and therefore section 951A of the US Internal Revenue Code is not a provision of a law of a foreign country that corresponds to sections 456 or 457 for the purpose of subsection 832-130(5).
In reaching this view, the Commissioner makes reference to the intention of the US GILTI rules as described by the US Congress and takes into account guidance from the Organisation of Economic Development and Cooperation (OECD) in relation to hybrid mismatch rules.
The ruling in the TD does not address the operation of the “basic” test in subsection 832-130(1) and its application in relation to the GILTI regime. In the draft TD, the Commissioner explained that subsection 832-130(5) “extends the meaning” of “subject to foreign tax”. However, in the explanation part of the TD (while not forming part of the binding public ruling) states that subsection 832-130(5) “does not merely clarify the definition” of “subject to foreign tax”. The reason for this change is not explained but further along in the explanation to the ruling, it is also stated that “where section 951A includes income or profits of a CFC in working out the tax base of a shareholder, the income or profits can only be regarded as being ‘subject to foreing income tax’…if section 951A corresponds to” the Australian CFC rules. The TD does not provide any support for this interpretation.
Notwithstanding that the legislation for the hybrid mismatch rules was introduced into Parliament more than four years ago, there continue to be a range of uncertainties in relation to the operation of the Australian hybrid mismatch rules that affect a broad range of taxpayers. Many of these arise from the requirement to make comparisons between Australian and foreign tax laws. In this regard, the TD provides helpful guidance in relation to the interpretative approach likely to be adopted by the Commissioner. In particular, the TD adopts a “gist” or purpose (rather than a mechanical comparison) approach to identifying corresponding tax rules and this may require particular elements of relevant tax laws to be considered. In addition, the TD confirms that reference should be made to the OECD guidance as well as the foreign legislative history and associated commentary in undertaking the required comparison. Taxpayers should take into consideration the Commissioner’s approach adopted in the TD when considering if foreing laws correspond to any of the Australian hybrid mismatch rules.
The TD applies both before and after its date of issue (the hybrid mismatch rules applied to tax years commencing on or after 1 January 2019).
The Commissioner has also released a guidance compendium which provides responses to comments received in relation to the draft TD. The compendium is not a publication that has been approved to allow a taxpayer to rely on it for any purpose and is not intended to provide advice or guidance, nor does it set out the Commissioner's general administrative practice.
The Commissioner has also recently released extensive tax return information reporting requirements (Section G of the International Dealings Schedule 2022) in relation to the Australian imported hybrid mismatch rules. These reporting requirements are creating significant uncertainty and compliance costs for all companies with deductible payments to foreign affiliates. These reporting requirements will apply to many taxpayers currently preparing to file tax returns for the year ended 31 December 2021 and taxpayers should also take note of the Commissioner’s compliance approach in relation to the imported hybrid mismatch rules.
The Takeaway
Taxpayers that have taken positions that income subject to the GILTI regime should be considered “subject to foreign tax” will need to consider the impact of the TD including the operation of the “basic” test which is not covered by the TD.
The TD may also provide an opportunity for more certainty in relation to the likely approach of the Commissioner in other aspects of the hybrid mismatch rules requiring a comparison between Australian and foreign tax laws.
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Michael Bona
Partner, International Tax & Trade Leader, PwC Australia
Tel: +61 405 136 010