Australian Parliament passes Bill for MAAL, CbC reporting and increased penalties with wider ATO public reporting

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1 4 December 2015 Global Tax Alert Australian Parliament passes Bill for MAAL, CbC reporting and increased penalties with wider ATO public reporting Private company tax data to be disclosed by ATO. Wide-ranging impact requires action by multinationals EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary On 3 December 2015, Australia s Senate passed (with late amendments) the Bill to implement the previously announced: Multinational anti-avoidance law (MAAL) to apply to foreign multinationals generating certain profits earned from Australia without an Australian permanent establishment Country by country (CbC) reporting to the Australian Taxation Office (ATO) Increased penalties for certain large company transactions There were no material changes to the MAAL and CbC legislation in the final Bill from what had previously been announced and included in the draft legislation. However, to secure support for the passage of the Bill, the Government agreed to two amendments: Significant global entities, that are Australian resident or a foreign resident with an Australian permanent establishment, will be required to file General Purpose Financial Statements (GPFS) for income years commencing from 1 July 2016.

2 2 Global Tax Alert The winding back of a recently-introduced exemption that protected majority Australian-owned private companies tax information from ATO public reporting, starting with the upcoming mid-december ATO disclosures. The amendment provides that Australian-owned private companies with revenue of A$200 million or more will have their tax data disclosed, in addition to majority foreign-owned companies. The House of Representatives agreed to the Bill as amended, and the Bill now awaits Royal Assent. Detailed discussion The MAAL and CbC reporting rules will commence on or after 1 January 2016 All significant global entities (SGEs) operating in Australia, being entities with global revenues greater than A$1 billion, will need to consider these rules and may need to review their structures. The Bill retains the significantly broadened scope of the MAAL, which has application to arrangements involving high tax jurisdictions as well as being based on a subjective and low threshold principal purpose test. While the ATO has provided a Law Companion Guideline on how the MAAL is to apply, more guidance is needed to allow a proper risk determination by multinational groups that will need to publicly report on uncertain foreign tax positions for Q1 in The Bill, as passed, is predominantly consistent with the measures introduced in September The Government agreed to certain amendments raised by the Greens in the Senate, but those amendments do not relate to the MAAL itself. The introduction of the MAAL is a unilateral action taken by Australia, which is out of step with the coordinated implementation and action in respect of recommendations set out in the final report for Action 7 of the Organisation for Economic Cooperation and Development s (OECD) base erosion and profit shifting (BEPS) action plan. Schemes The new rules will apply to a scheme, in connection with which: A foreign entity supplies goods or services to its Australian customers Activities are undertaken in Australia directly in connection with the supply Some or all of those direct activities by an associate or commercially dependent entity support the foreign resident in providing that supply The foreign entity derives ordinary or statutory income from the supply Some or all of that income is not attributable to an Australian permanent establishment of the foreign entity The foreign entity is a SGE for the year of income (i.e., it is a global parent entity or a member of a consolidated accounting group that has annual global income exceeding A$1 billion in the year (based on accounting principles)) and There is a principal purpose of obtaining a tax benefit or reducing a tax liability under a foreign law (tax advantages) Purpose The new rules apply where it would be concluded that one or more of the relevant persons entered into or carried out the scheme to enable one or more taxpayers to: Obtain an Australian tax benefit or Obtain both a tax benefit and a reduction (including a deferral) to one or more other tax liabilities arising under foreign law. The Government has retained the principal purpose threshold test for the MAAL, which represents an extension of the regular Part IVA provisions which require a sole or dominant purpose of obtaining an Australian tax benefit. The principal purpose rules are stated to be consistent with the language of the OECD report on Action 6 of the BEPS Action Plan to prevent the obtaining of tax treaty benefits in inappropriate circumstances. The new measures do not limit the application of the other Part IVA provisions. Low tax foreign jurisdictions no longer necessary The Bill is not limited to a low tax jurisdiction with a carveout for substantial operations in that country. Instead, the ATO is to have regard, in considering whether there is a principal purpose of seeking the relevant tax advantages, to the extent to which the activities that contribute to bringing about the contract for the supply are performed, and are able to be performed by relevant companies.

3 Global Tax Alert 3 Simple examples in the Explanatory Memorandum to the Bill include: A significant operation of a foreign company in a low tax jurisdiction, with a conclusion that there will be no relevant tax avoidance purpose and An operation of a foreign company in a low tax jurisdiction, with royalties to another entity in a low tax jurisdiction, with no substantial activities in either, with a suggestion that there will be a relevant tax avoidance purpose. The impact of this rule is not clear in a group with a complex supply chain that does not fit easily into the simple examples. There is still concern that the removal of the low tax foreign jurisdiction qualification could result in the imposition of tax administrative penalties in circumstances where a double tax treaty limits Australia s taxing rights where the income is otherwise returned in a high tax jurisdiction such as the United States. Tax Benefits in Australia or other countries The tax benefit for the purpose of the MAAL is broadly the Australian tax which would have been attributable to an Australian permanent establishment. Tax benefits encompass both income taxes and other Australian tax obligations such as royalty and interest withholding tax. The concept also includes reducing, for one or more foreign taxpayers, their liabilities to tax under a foreign law, in connection with that scheme. This also includes a deferral of tax liability unless there are reasonable commercial grounds for the deferral. The phrase reasonable commercial grounds is briefly explained in the ATO s Law Companion Guideline for the MAAL. Application The new rules will apply on or after 1 January 2016 in connection with a scheme, whether or not the scheme was entered into, or was commenced to be carried out, before that day. This means that entities have until 1 January 2016 to review their arrangements and determine whether any restructuring is required. Further, the measure does not apply in relation to tax benefits that a taxpayer derives before 1 January The ATO can issue an assessment to cancel a relevant tax benefit and impose penalties on SGEs of up to 120% of the increased tax assessment (where aggravating factors apply, such as obstructing information from the ATO). ATO Law Companion Guideline (LCG) on the MAAL EY took a leading role through the consultation process in highlighting to the ATO and Treasury that guidance needed to be introduced and resolved speedily, given that foreign multinationals might have financial reporting requirements in relation to tax risks generated by the MAAL, pending resolution of all the risk issues. The ATO issued the LCG for the MAAL in November With the enactment of the Bill, the ATO s LCG is to become a public taxation ruling. The ATO s LCG provides a high level roadmap of the issues and processes involved with the MAAL, with some scoping material to assist multinational entities in determining whether or not they are subject to the MAAL. The ATO s LCG also provides guidance on a number of technical and practical issues raised during the consultation processes, including: The principal purpose test Reduction or deferral of foreign tax liabilities Identifying the tax benefit for schemes caught by the MAAL Profit attribution to the notional permanent establishment The ATO s LCG, however, does not include detailed MAAL administration processes as each taxpayer s circumstances will be different. Taxpayers might select processes involving a mix of private rulings, advance pricing agreements, and settlements because they may need to cover three separate periods, being: The past, historical issues prior to the MAAL The future, after affected companies restructure to de-risk their value/supply chains and Transitional periods, given that many restructures will not be completed by the 1 January 2016 start date for the MAAL However, the ATO s guidance still does not provide sufficient certainty for multinationals with Q1, 2016 reporting requirements. Next steps for foreign multinationals All foreign enterprises with global turnover over A$1 billion making direct supplies to Australian customers (which may include supplies of services, loans and licensing revenues such as royalty arrangements) and having any

4 4 Global Tax Alert form of dependent or associate representative presence in Australia will need to review their structure and how their business model is applied in practice. The changes create tax risk that could require a financial statement disclosure if not properly addressed. Direct cross-border sales to Australian customers without any Australian presence or through an independent broker or agent should not be subject to these changes, provided the broker/agent s revenue from one foreign supplier does not make them commercially dependent for these purposes. Australian buy/sell entities or limited risk distributors should not be caught by the rules but taxpayers should review their model to ensure that there are not also direct cross-border sales that could taint the business model. Similarly commission agent structures may be sustainable: however it is likely that an Advance Pricing Arrangement may be necessary to provide a level of assurance around tax risk. For foreign enterprises which form the view that a marketing and sales operation needs to convert to a buy/ sell, limited risk distributorship or some other form of commission agent structure this will involve significant change management and as the rules will take effect from 1 January 2016, the need for change should be assessed urgently planning for any restructure may require early engagement with the ATO to resolve tax risks. General Purpose Financial Statements (GPFS) Although the MAAL may only apply to a small subset of the 1,000 or so identified SGEs with an Australian presence, the Senate amended the Bill to require SGEs to prepare and file GPFS with the ATO commencing for income years starting on or after 1 July An SGE that is an Australian resident, or a foreign resident with an Australian permanent establishment, will be required to provide a GPFS on or before the day the entity is required to file its income tax return with the ATO. The ATO must give a copy of the GPFS to the Australian Securities and Investments Commission (ASIC). This new requirement for multinationals to prepare and file GPFS was developed without public consultation and will impose an additional compliance burden on groups where existing financial reports do not satisfy the new requirements. The relative cost may be significant for SGEs with Australian operations which have very small turnover. Senate winds back laws that protected certain Australian-owned private companies from the ATO s public reporting The changes amend the November 2015 law that exempted all majority Australian-owned private companies whose total income exceeded A$100m from having their tax information published by the ATO. Senate amendments to the Bill, agreed to by the Government, wind back that exemption whereby the exemption will be limited to majority Australian-owned private companies with revenue under A$200m. So, ATO public reporting will now apply to: Public companies with total income exceeding A$100m Majority Australian-owned private companies with total income exceeding A$200m Non-majority Australian-owned private companies with total income exceeding A$100m These amendments apply to the and following income years and will be applicable for the upcoming mid- December ATO disclosures. Next steps Affected private companies now need to prepare for their tax affairs to be disclosed, with the need to consider their actions if their apparent tax rate appears low, for whatever reason. SGEs with an Australian presence will need to prepare and file general purpose financial reports with the ATO. Multinationals with a significant presence in Australia will need to consider the impact of the ATO s upcoming public report on companies tax information, including addressing potential media scrutiny, reputational risks, and consider proactive disclosures for future ATO reports. Transfer pricing documentation and Country-by- Country (CbC) reporting The Bill, as passed, implements additional transfer pricing documentation requirements and CbC reporting into Australian domestic law, with application to income years commencing on or after 1 January The ATO estimates there are approximately 1,300 1,500 groups affected, being Australian headquartered groups and Australian subsidiaries of foreign groups that are SGEs with global turnover exceeding A$1 billion.

5 Global Tax Alert 5 The Bill provides the ATO with the flexibility to establish approved forms, and the ATO recognizes that it needs to provide more direction on both the technical and practical aspects of the new rules. The ATO is developing a CbC Law Companion Guide, looking to the more technical aspects of the legislation, which will convert into a ruling. In addition, the ATO is preparing a broader compliance guide that will have a more practical focus, including how exemption powers will be applied. SGEs with an Australian presence will need to provide the following three documents to the ATO unless specifically exempted: A CbC report containing information on the location of the economic activity undertaken by the multinational group (including revenue, headcount, main business activities, taxable income and tax paid in each tax jurisdiction globally) A master file, which provides a high-level description of the multinational group s business operations A local file, which describes the Australian entity s operations and support for its cross border related party dealings The above three documents are expected to operate principally as risk identification tools and not as primary compliance data sources for the ATO. The ATO expects the master file and local file will be shared with other countries tax authorities upon request under normal treaty mechanisms. Data formats under development early 2016 target date SGE companies will need to prepare to implement the data formats for the reports, which are planned to be all-electronic. The OECD has specified that the CbC reporting is to use a XML schema, to facilitate collection and exchange. The ATO expects that master files and local files (and any attached documents) will be filed electronically in Australia. The ATO is participating in the OECD CbC reporting development team and the data specifications are planned for completion by early Reports will need to be lodged by the end of the year following the relevant year. The first reports for a Decemberbalancing group would prima facie be filed by the end of 2017 unless: They are breaching the A$1 billion threshold for the first time (in which case they are now given an additional year to get ready for reporting) or An exemption has been provided by the ATO. A particular class of entity may be exempted by the ATO by legislative instrument. A local entity may only be required to provide the master file and local file to the ATO, if its global parent entity has made a CbC report available to a tax authority in a jurisdiction with which Australia has an information-sharing arrangement in place and the ATO will receive the CbC from the other tax authority. Similarly, a local entity may not need to provide the master file if another member of its multinational group that is an Australian resident has provided the master file to the ATO. Late filing, or filing of these statements not in the approved form, may trigger administrative penalties. However, regardless of whether an entity fails to provide a statement on time, or in the approved form, it would still be eligible to have a reasonably arguable position (RAP) in relation to a transfer pricing matter if it meets the transfer pricing documentation requirements (in section of Schedule 1 to the Tax Administration Act 1953). Entities must continue to lodge an International Dealings Schedule in their income tax returns and maintain specific transfer pricing documentation to maintain a RAP for transfer pricing purposes. The doubling of scheme penalties for significant global entities without a RAP significantly increases the relative importance of having transfer pricing documentation for Subdivisions 815-A to 815-D of the Income Tax Assessment Act Next steps for multinational groups affected by CbC requirements Companies implementation plans for CbC reporting need to be flexible, allowing for changing requirements as the CbC reporting implementation progresses and evolves globally. A CbC readiness review and pilot can assist companies in identifying and heading off risks, and evaluate and address any gaps in information or potential for misinterpretation in advance.

6 6 Global Tax Alert Doubling of tax avoidance scheme penalties for significant global entities The amount of the penalty imposed for entering into any tax avoidance or profit shifting scheme is doubled for SGEs that do not have a RAP. Tax avoidance schemes include profit-shifting schemes where the taxpayer has a sole or dominant purpose of obtaining a transfer pricing benefit from the scheme. The increased penalties do not apply where the taxpayer has a RAP. Penalties are expressed as a percentage of the relevant scheme shortfall amount. These changes have significant impact on tax compliance strategies for larger affected companies. The Explanatory Memorandum to the Bill summarizes the new penalties which apply to scheme benefits that an entity gets in relation to an income year commencing on or after 1 July 2015 (regardless of when the scheme was entered into or carried out). Base penalty (%) If aggravating factors (e.g., obstruction) apply (%) Voluntary Disclosure during examination (%) Voluntary Disclosure after examination (%) Tax avoidance Scheme [and penalty where there is a RAP] 100 [25] 120 [30] 80 [20] 20 [5] Profit-shifting Schemes [RAP] 50 [10] 60 [12] 40 [8] 10 [2]

7 Global Tax Alert 7 For additional information with respect to this alert, please contact the following: Ernst & Young (Australia), Sydney Daryn Moore daryn.moore@au.ey.com Paul Baulkus paul.balkus@au.ey.com Jesper Solgaard jesper.solgaard@au.ey.com Ernst & Young LLP, Australian Tax Desk, New York Andrew Nelson andrew.nelson@ey.com

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