- In order to properly assess, and develop policy responses to, the risks to the sustainability of Australia's corporate tax base from exploitation of international tax rules, it is necessary to have a framework for assessing business taxation in general. This can guide an understanding of what should, and should not, fall within Australia's jurisdiction to tax.
- This chapter considers the benchmarks for assessing business tax including those discussed in the significant reviews that have examined business tax settings in Australia over the past four decades. The chapter goes on to examine the frameworks underpinning Australia's jurisdiction to tax and the enabling concepts used to give effect to those frameworks.
2.1 Benchmarks for Assessing Business Taxation
- Australia's business tax system has been the subject of a number of major reviews over recent decades, including the 1975 report of the Taxation Review Committee chaired by Justice Ken Asprey (the Asprey Report), the 1985 White Paper on Taxation, the 1999 Review of Business Taxation chaired by John Ralph (the Ralph Review), and the 2009 AFTS review.
- Each of these reviews included discussion and analysis on the appropriate benchmarks or frameworks for thinking about the tax system generally and, in some cases, the business tax system in particular. Notwithstanding some points of difference in detail and emphasis, there has been a striking level of agreement around the three benchmarks set out in the Asprey Report: equity, economic efficiency and simplicity (Asprey, 1975). The Ralph Review highlighted the importance of ensuring the dynamic robustness of the tax system, including the ability to accommodate changes in the business environment (Review of Business Taxation, 1998). The AFTS review also emphasised the sustainability of the tax system and the importance of policy consistency, the idea that 'rules in one part of the system should not contradict those in another part of the system'.3
- The benchmark of economic efficiency is often used interchangeably with the objective of optimising economic growth. A key principle in achieving this benchmark is neutrality: limiting the extent to which the tax system affects economic choices. This is important given all taxes create a drag on economic efficiency which results in a key objective of tax policy being to impose taxes in such a way as to minimise the adverse impact on economic activity.
- In an international context, a key conceptual challenge is determining the appropriate comparator for neutrality. Capital export neutrality aims for neutrality in international investment decisions. It is achieved where an investor from a particular country faces the same effective tax rate on an investment regardless of the country of investment. Capital import neutrality is achieved when an investment has the same effective tax rate (and therefore after-tax return) for both domestic and foreign investors. For capital import and capital export neutrality frameworks to work optimally, every jurisdiction would need to have the same tax base and the same rate. Given this is unrealistic these concepts serve as a benchmark rather than a practical goal.
- In most cases it is not possible to simultaneously achieve capital import and export neutrality, requiring a choice to be made between the benchmarks. The Ralph Review described this as a 'dynamic balancing act', concluding that:
Australia must ensure that its international tax arrangements attract desirable inbound investment, do not detract from the incentives Australian entities have to remain domiciled here, recover an appropriate return from both inbound and outbound investment, and further the competitiveness of the economy generally.
(Review of Business Taxation, 1998, p. 77)
2.2. Australia's Jurisdiction to Tax
- An analysis of the risk of the erosion of Australia's corporate tax base from base erosion and profit shifting activity by multinational enterprises requires a sound conceptual framework setting out what should, and should not, properly fall within Australia's jurisdiction to tax. This is a separate question of what currently is, or could be, within the jurisdiction to tax.
- Historically, the most influential conceptual frameworks underpinning the division of taxing rights between countries have been the benefit doctrine and the economic allegiance doctrine. The benefit doctrine bases a country's claim to the taxation of residents and non-residents on the use of benefits provided by the country, while the economic allegiance doctrine bases taxation rights on the existence and extent of the economic relationships between the country and the income or person concerned. Given the nature and shape of the economy in the early twentieth century, in the majority of instances the economic allegiance and benefits doctrine would have yielded very similar conclusions on countries' jurisdiction to tax.
- While there have been significant changes in the global economy since these doctrines were first developed, they continue to articulate the nature of relationships between a jurisdiction and economic activity and therefore remain relevant, encompassing the conceptual case for claiming taxing rights. However, a key issue is whether the economic allegiance doctrine and benefits doctrine give the same conclusions on jurisdiction to tax where the location of economic activity is unclear. If not, the challenge is to determine which doctrine should have primacy.
- Countries can assert the right to tax to the limit of their sovereignty. There are two aspects of a country's sovereignty: the people (its citizens and residents) and territory it claims authority over. Traditionally, the application of the economic allegiance and benefits doctrine, combined with the practical limits on countries' ability to assert sovereignty, gave rise to the two concepts that underpin the international framework for the taxation of cross-border income and capital: the residence (of individuals and entities) and the source (of income).
- A related issue then is whether the concepts of source and residence continue to represent a reasonable proxy for the economic allegiance and benefit doctrines in the modern economy. In particular, it is arguable in relation to the digital economy and the broader knowledge economy that the concepts of source and residence may no longer adequately reflect the economic allegiance and benefits doctrine. That is, it is important not to lose sight of the fact that 'source', 'residence' and 'permanent establishment' are the tools for allocating taxing rights rather than the guiding conceptual frameworks.
- The concept of 'permanent establishment' draws on elements of the concepts of 'source' and 'residence'. It seeks to treat part of an entity as a resident when it has a significant physical presence in a jurisdiction. Business profits of a permanent establishment are then effectively deemed to have a source in that jurisdiction.
3 While framed in the context of the AFTS discussion on interactions between the tax and transfer system, it is equally applicable in relation to when thinking, for instance, about international tax settings and other aspects of international trade policy.