Tax Alert. Multinational businesses and tax - Australian Taxpayer Alerts on four structuring issues. At a glance

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1 April 2016 Tax Alert Multinational businesses and tax - Australian Taxpayer Alerts on four structuring issues At a glance ATO issued Taxpayer Alerts covering certain arrangements for Thin capitalisation and intangibles Agency & distribution agreements to overcome the MAAL Cross border financing and swaps Cross border leasing Determine whether any of 4 Taxpayer Alerts may be relevant for previous, current or future arrangements Ensure any relevant arrangements are documented to prepare for ATO questioning and scrutiny On 26 April, the Australian Taxation Office (ATO) issued 4 Taxpayer Alerts (TAs) in relation to practices being undertaken by certain multinational businesses (MNEs) where it has concerns about the tax outcomes being sought. The TAs are not formal binding ATO advice, but are intended as ATO warnings to MNEs involved in these activities to seek independent advice in relation to their positions, to highlight ATO compliance action with potential penalty exposures, and to prepare for ATO examination of the issues and willingness to contest the issues. The four TAs are: TA 2016/1 Inappropriate recognition of internally generated intangible assets and revaluation of intangible assets for thin capitalisation purposes. The ATO outlines general principles and specific examples of what in their view does not meet the requirements for recognition of assets and questionable revaluations. TA 2016/2 Interim arrangements in response to the Multinational Anti-Avoidance Law (MAAL). The ATO has seen certain specified arrangements to avoid the MAAL, which took effect on 1 January 2016, and the TA expresses concerns about these. Companies planning restructure proposals or approaching the ATO will benefit from reviewing this TA. A senior ATO officer stated on 27 April that the ATO is in discussions with about 170 groups on the MAAL. TA 2016/3 Arrangements involving related party foreign currency denominated finance with related party cross-currency interest rate swaps. This covers certain related party cross-currency interest rate swap agreements which achieve, in the ATO s view, contrived thin capitalisation, withholding tax, and transfer pricing outcomes. TA 2016/4 covers cross-border leasing arrangements involving mobile assets (particularly lease in lease out (LILO) arrangements). Businesses involved in any arrangements that might potentially fall within the sphere of the TAs should ensure the arrangements are fully documented and they are ready for ATO scrutiny. The TAs also provide useful pointers to arrangements which are more likely to be acceptable to the ATO. The need for affected entities to prepare for ATO questions is heightened by the doubling of penalties for certain schemes entered into by significant global entities (broadly turnover in excess of A$1 billion) but not supported by a reasonably arguable position.

2 ATO issues 4 Taxpayer Alerts on multinational profit shifting On 26 April 2016, the ATO issued 4 TAs in relation to certain practices being undertaken by MNEs. The objective of the TAs is to signal ATO preliminary concerns about tax outcomes being sought in four international tax areas. A senior ATO officer stated in a radio interview on 27 April that we are hoping the companies never enter into these schemes rather than waiting for them to enter into the scheme and then capture them The TAs cover: intangible asset recognition and valuation for thin capitalisation purposes (TA 2016/1); arrangements to avoid the MAAL (TA 2016/2); related-party finance using foreign currency loans and derivatives (TA 2016/3); and cross-border leasing arrangements involving mobile assets (TA 2016/4). The ATO has been signalling for some time that these TAs were being developed. The timing and combination of their release follows the ATO s attendance at 21 April hearings by the Senate Economics References Committee inquiry into claimed corporate tax avoidance (Senate Inquiry) in which the ATO referred to some MNEs as gaming the system. This suggests the ATO wishes to demonstrate its pursuit of MNEs using its existing powers. As the Senate Inquiry is proposed to continue until 30 September 2016, the ATO may refer to the TAs and their results when next called before the Senate Inquiry. TA 2016/1 - thin capitalisation, asset recognition and valuation This sets out the ATO s concerns in regards to taxpayers use of inappropriate intangible asset recognition and valuation practices for thin capitalisation purposes. These concerns flow from practices and arrangements that effectively facilitate either additional debt deductions (which would have otherwise been denied under thin capitalisation rules), or an increase to entities debt-loading capacity for future income years. TA 2016/1 provides examples of arrangements of concern, including: choices to recognise internally generated items, where the item chosen does not meet the relevant intangible asset recognition criteria set out in the Australian Accounting Standard AASB 138 Intangible Assets thus impacting the thin capitalisation calculation; and specific asset revaluation practices involving unsound assumptions, generic materials, double counting of asset values across multiple intangibles, and economic returns that do not accrue to the taxpayer; and failures to impair the value of assets (as required by AASB 136 Impairment of Assets) where the fair value or cash generating unit has declined. The ATO continue to review these arrangements and have commenced compliance activities in some cases, having received favourable external advice on the application of the relevant accounting standards. These have resulted and will continue to result in adjustments to taxpayers tax assessments. The TA also flags ATO action including: contesting the recognition of relevant assets, and adjusting the valuation of relevant assets. As well, more broadly, the Commissioner is also considering the extent of his power to substitute more appropriate asset values where the Commissioner considers that an entity has overvalued its assets, and the circumstance in which it would, or might be appropriate to exercise this power. We expect the ATO will continue to be proactive in: qualitatively analysing arrangements through compliance activities; substituting asset values; and preparing and issuing guidance products on the technical accounting and tax law positions. Taxpayers that have made choices to recognise or revalue assets for their thin capitalisation calculations, or are considering these options, need to ensure that the position taken are both compliant with Australian Accounting Standards and supported by relevant documentation. EY can assist taxpayers in reviewing their arrangements (current or proposed) for thin capitalisation purposes, having regard to both accounting standards and the income tax law. April 2016 Page 2

3 TA 2016/2 MAAL: agency and purported distribution agreements TA 2016/2 sets out the ATO s concerns in regards to certain taxpayer interim arrangements in response to the enacted MAAL. The concerns flow from what the ATO considers are artificial and contrived interim measures solely designed to avoid the application of the MAAL. It provides examples of arrangements of concern, including: purported agency agreements between the foreign entity and an Australian entity, which effectively preclude the application of the MAAL (agency case); and the substitution of licensing agreements (e.g. for the use of intellectual property) with distribution agreements, which the ATO consider to be an attempt to escape withholding tax obligations under the auspices of a distribution fee (re-characterisation case). The core of the ATO s concerns relates to the large quantum of income tax involved and the qualitative nature of interim arrangements put in place in response to the MAAL. In the agency case, the ATO s concerns are that the functions undertaken, assets used, and risk assumed are neither appropriate nor consistent with parties dealing with each other at arm s length. In the recharacterisation case, the ATO s concerns focus on the foreign entity s lack of rights to make supplies under the purported distribution agreement. Following on from the ATO s MAAL Client Experience Roadmap (released in January 2016), the ATO continues to engage with taxpayers in regards to restructuring their arrangements in response to the MAAL and policing restructures. In a radio interview on 27 April a senior ATO officer noted that the ATO is currently in discussions with 170 or so companies as to whether they are caught by that law and how they should respond to that law. This highlights the ATO focus on the MAAL. Taxpayers proposing or using an agency or recharacterisation case to the ATO will be subject to greater scrutiny, which may include: whether the distribution and agency structure is tax driven and legally effective; and if the arrangement is consistent with the economic substance and commercial realities of activities carried out in Australia. The ATO is engaging with relevant taxpayers to explore the issues of concern and to ensure that arrangements do not seek to avoid the application of the MAAL in an artificial and contrived manner. Affected taxpayers need to consider the legal and tax consequences of these arrangements and prepare for ATO scrutiny and potential ATO compliance activities. Preparation is all the more significant given the risk of penalties involved. TA 2016/3 cross-border relatedparty financing TA 2016/3 sets out the ATO s concerns in regards to taxpayers use of related-party financing involving foreign currency loans and derivatives. The ATO states its concerns are that multiple, linked, excessively complex arrangements appear to be designed to achieve contrived thin capitalisation, withholding tax, and transfer pricing outcomes. It provides examples of features and associated issues, including: cross-border related-party derivative transactions which either claim or do not have a hedging/offsetting rationale, and/or hedges/offsets another cross-border relatedparty transaction; economic and/or accounting exposure or risk, which the derivative is claimed to hedge, is not required to be further addressed at the global group level; net pre-tax financial outcome to the Australian group is neutral or negative, with the net financial benefit to the group flowing from the Australian tax savings from the arrangement; incorrect pricing or mispricing of the related party derivative and/or an embedded high profit margin for the offshore related derivative counterparty; deductibility of payments under the related party derivative; and/or whether the related party derivative and/or the related party borrowing are on non-arm s length terms or involve non-arm s length considerations. The ATO continue to review these arrangements, with compliance activities commenced in some cases. The ATO are expected to develop their April 2016 Page 3

4 technical position on the arrangements, and will canvass their concerns in due course. Taxpayers that have entered into or are contemplating entering into related-party financing involving foreign currency loans and derivatives need to consider their position and prepare for ATO compliance activity. TA 2016/4 cross-border leasing arrangements TA 2016/4 sets out the ATO s concerns in regards to taxpayers use of cross-border leasing arrangements involving mobile assets, particularly asset leasing between related parties. These concerns flow from arrangements featuring: the use of interposed companies for favourable tax treaty treatment, and disproportionate amounts of taxation relative to contributions made by Australian operations. It provides examples of the ATO s concerns, including: transfer pricing and profit attribution approaches that are inconsistent with arm s length leasing arrangements and/or do not reflect the ATO view on the true Australian economic contribution; potential application of withholding tax to certain lease payments; the potential liability of a treaty resident head lessor to Australian tax as the head lease payments may be deemed by the relevant treaty to have an Australian source for Australian income tax law purposes; and sub-lessor entities having limited commercial activities or limited sound commercial reasons for their position in the leasing arrangement. These concerns align with those raised to date by the ATO in its LILO project and interactions with taxpayers in the oil and gas services industry. Going forward, we expect the ATO will continue to be proactive in: formalising the outcomes of the LILO project; reviewing common cross-border leasing arrangements; consulting with stakeholders to develop their commercial and tax technical understanding of these arrangements; and preparing and developing guidance on the transfer pricing and profit attribution issues associated with common cross-border leasing arrangements. Taxpayers that have entered into, or are contemplating, cross-border leasing arrangements need to review and/or document positions to support the commercial and economic rationale of the leasing structure utilised to bring assets into Australia. How EY can help EY can assist in reviewing whether any arrangements fall within the ambit of the concerns voiced by the ATO in these four TAs. EY can provide guidance on documenting businesses positions and how to interact with ATO either proactively or in response to queries. What this means for you Businesses involved in any arrangements that might potentially fall within the sphere of the TAs should ensure that they are documented and ready for ATO questioning and scrutiny. The TAs also provide useful pointers to arrangements which are more likely to be acceptable. Affected entities need to factor the guidance into their risk management and compliance processes. The need for affected entities to prepare for ATO questions is heightened by the doubling of penalties for certain schemes entered into by significant global entities (broadly turnover in excess of A$1 billion) but not supported by a reasonably arguable position. April 2016 Page 4

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