- As discussed in Chapter 4, risks to Australia's corporate tax base have both fiscal and broader economic impacts. In addition, erosion of corporate tax bases globally implies the scope for action is beyond any single country acting independently. It is therefore important that Australia's interests are prosecuted through multilateral forums.
- The Issues Paper noted that a number of different perspectives on both the extent of problems with current tax rules and the most appropriate solutions, and the nature of the issues involved, mean that policy approaches are likely to be pursued at a range of different levels and over different time periods. This includes improving compliance with existing rules, unilateral and multilateral policy responses, and measures to improve the monitoring of risks.
- Many submissions noted that as Australia already had among the most robust corporate tax rules and compliance arrangements of the OECD, the focus of Australia's policy response to the risk of corporate tax base erosion should be in shaping and leading efforts to improve multilateral reform efforts.20
- The section concludes with an analysis of the proposed OECD-G20 Action Plan to address base erosion and profit shifting.
- Australia's company income tax revenue as a proportion of GDP at 4.25 per cent is higher than the OECD average of just over 3 per cent. This is attributable to Australia's comparatively high levels of corporate sector profits, particularly from the resource sector, and effective enforcement, rather than reflecting the level of Australia’s corporate tax rate, which is generally in line with OECD economies.
- This greater reliance on corporate tax means that Australia is more vulnerable to corporate tax base erosion than other OECD countries. As such, it is important that policy and administration are vigilant in addressing risks as they are identified. This was generally acknowledged in submissions on the Issues Paper:
Australia is right to remain vigilant and encourage a comprehensive co-ordinated approach by jurisdictions to target tax avoidance and evasion through profit shifting and ensure Australia's tax laws are adequate to deal with profit shifting.21
- Australia's relatively high level of corporate tax collections also means that base erosion and profit shifting could have significant adverse consequences for the broader economy and individual welfare. Falling company tax receipts would require an additional share of the taxation burden to fall on other taxpayers, which may not align with Government objectives.
- In addition, base erosion and profit shifting could undermine economic efficiency, as some businesses, such as those which operate cross-border and have access to sophisticated tax expertise, may have greater access to these opportunities, providing them with a competitive advantage compared with enterprises that operate mostly at the domestic level. This would have distortionary effects on the allocative efficiency of the economy.
- An increasing awareness of tax avoidance being undertaken by some taxpayers also has the potential to erode broader confidence in the tax system. If taxpayers (including individuals) think that multinational corporations can structure their affairs to take advantage of differences in countries' tax laws it could undermine voluntary compliance by all taxpayers — upon which modern tax administration depends.
- Examples of such practices, and accompanying costs, have found their way into public discourse in recent times due to several prominent cases where tax planning has yielded low effective rates of taxation on group income over recent years.22
- The importance of community confidence in the tax system was noted by a number of submissions to the issues paper. In this context it was noted that it was important for this debate to be measured, balanced, and well informed.
- Australia has a clear national interest in and seeks to support the development of other countries.
- A number of submissions to the Issues Paper highlighted the importance of a strong and sustainable tax base in fostering the independent economic and institutional growth of a country, allowing developing countries to move away from an over-reliance on foreign aid. These submissions argued that Australia's broader national interest was served by supporting approaches to base erosion and profit shifting that improved the ability of developing countries to address these challenges. In particular, the Tax Justice Network argued that:
Australia's aid program includes the objectives of 'improving incomes, employment and enterprise opportunities for poor people' and 'improving governance in developing countries to deliver services, improve security, and enhance justice and human rights for poor people. To have any hope of fulfilling these aims it is necessary to ensure developing country governments are able to generate enough sustainable revenue for themselves.23
- The nature of these challenges were highlighted in the OECD's report released earlier this year:
Developing countries often have no rules or ineffective rules for dealing with BEPS issues and lack the capacity to draft effective rules. They also face significant challenges in obtaining the relevant data and information to enable them to effectively implement their rules. The other major challenge facing developing countries is building the capacity to effectively implement rules based on international standards.
(OECD, 2013, p. 87)
- The February 2013 OECD report recognised that improving compliance with the existing tax laws of countries, including through more effective enforcement action by tax authorities, had an important part to play in addressing base erosion and profit shifting.
- Increasingly revenue authorities are realising the benefits of cooperation in developing a more complete understanding of the value chains of multinational enterprises, with this being a central theme of the recent OECD Forum of Tax Administration in Moscow on 16-17 May. The communiquè from the Forum noted that:
We will rapidly increase the use of the provisions of the greatly expanded network of agreements allowing for exchange of information, including by providing necessary training to tax auditors, and we will ensure effective and secure use of information received under those agreements.24
- Submissions on the Issues Paper noted that the ATO is an effective tax administration that has a strong reputation internationally. The 2013-14 Budget also provided the ATO with additional funding to increase its focus on areas with a high risk of base erosion and profit shifting including areas like offshore marketing hubs and business restructures.
- Australia also undertakes considerable capacity building work in the region. An important element in improving collaboration between revenue authorities is to build the capacity of emerging and developing count
ries by sharing expertise and knowledge. Capacity building can offer enhanced outcomes for governments seeking to enforce their taxing rights both under existing arrangements and future changes. Consistent with this approach the OECD has launched a feasibility study into an initiative Tax Inspectors Without Borders that would seek to provide assistance to tax authorities, particularly in relation to complex audit activity.
- There is an increasing focus by some groups on the role that tax transparency can play in addressing base erosion and profit shifting issues. The Government recently enacted reforms to Australia's own tax confidentiality provisions to enable the public disclosure of certain tax information by large corporate entities.
- A number of submissions on the Issues Paper also stressed the importance of increased transparency to addressing base erosion and profit shifting, both in Australia and particularly in developing countries. Other submissions were more cautious, noting that increased transparency could have costs as well as benefits.
- A key reason for this diversity of views is that there are different perspectives on the policy objective of increased tax transparency, and a range of definitions of what it means in practice.
- In general terms, there are two broad objectives of increased tax transparency: improving compliance with the current tax law and informing public policy debate on what those laws should be. In both cases, these objectives can be further refined in terms of whether the focus is on tax evasion (where a taxpayer wilfully ignores their obligations under the law) and tax avoidance and minimisation (where a taxpayer seeks to act within the law to avoid or minimise a tax liability). Further, public policy debate could be focused on a specific area of the tax law or broader questions of the sustainability of the tax system.
- Similarly, the design of tax transparency tools revolves around two essential questions: what is the nature and level of information to be disclosed and to whom should it be disclosed? The information disclosed can range from disclosing the level of tax payable in a jurisdiction to providing detailed explanations of the nature and extent of complex transactions with significant potential taxation implications. Similarly, in some cases information exchange could be limited to tax authorities while in other situations public disclosure is envisaged.
- A key policy question is how best to match the transparency tools with the policy objective in each circumstance.
- There can be costs as well as benefits from tax transparency which in turn can affect the effectiveness of achieving its desired objective. For example, a traditional rationale for the confidentiality of taxpayers' information provided to tax authorities is that the frankness required for effective compliance with the tax law would be undermined if this information was made public. On the other hand, there is a strong argument that rules governing confidentiality of multinational tax affairs have inhibited the ability of national governments to put in place effective laws to address base erosion and profit shifting.
- This highlights the importance of being clear on the objective of a tax transparency measure, and targeting the measure to best meet that objective.
- The Issues Paper noted that while countries should take immediate action to address integrity concerns in relation to the tax law, there was a risk that this would result in double taxation unless this was done consistently within the existing international framework.25
- Submissions on the Issues Paper argued that Australia's corporate tax rules were among the more robust in the OECD, and that they had been further strengthened by recent reforms to transfer pricing and general anti-avoidance rules, along with several integrity measures announced in the 2013-14 Budget. In addition, the Government recently announced a Board of Taxation review of Australia's debt and equity rules that amongst other things will examine whether the system can be improved to address inconsistencies between Australia's and other jurisdictions' rules that could give rise to tax arbitrage opportunities.
- Overall, this suggests that there are unlikely to be substantial additional policy reforms that Australia could enact unilaterally in the short term to address base erosion and profit shifting. Nevertheless, the pace of innovation in tax planning, even purely within a domestic setting, reinforces the need for governments to be able to respond where necessary to emerging risks.
- This points to the need for a regular report to be prepared on the health of the business tax system generally, and the emergence of risks. This could include presentation of case studies of transactions and structures that present risks to the corporate tax base, along with a more detailed level of data on the business tax system than presented in the ATO's Taxation Statistics publication. Consistent with feedback from submissions, the report should fully utilise data before seeking additional information from taxpayers.
- The current public release of taxation statistics should be expanded to better cover international dealings of multinational enterprises.
- An annual report on the health of the business tax system should be published.
- Another possible focus of attention is on re-examining areas where Australia has restricted its taxing rights. This could include formalising a periodic, systematic review of Australia's bilateral tax treaties to ensure they are still in the national interest. The majority of Australia's 44 treaties were signed (or last amended) prior to 2000, with 15 treaties dating back to the 1970s and 1980s. As a result, most of Australia's treaties predate current tax treaty policy settings and recent developments in international business practices.
Each of Australia's bilateral tax treaties should be reviewed at least once a decade, in order to ensure that they continue to be in the national interest.
- Following the success of the Global Forum on Transparency and Exchange of Information for Tax Purposes, Australia has made substantial progress in building its network of exchange of information agreements. There is an international consensus that countries should implement measures to defend their tax bases from evasion involving jurisdictions that are unwilling to engage in effective exchange of information. The Global Forum is in the process of completing its evaluation of whether member countries are effectively exchanging information.
Australia should consider exploring options to further improve the way tax authorities work together including through expanded and more timely exchange of information for tax purposes.
- The February 2013 OECD report highlighted the need to update the international tax architecture to reflect changes in the global economy and the evolution of business practices. Achieving meaningful multilateral policy reform will be difficult, as countries have a range of interests and perspectives. On the other hand, in the absence of a credible plan to develop and implement multilateral reforms it is more likely that governments would undertake 'unilateral and uncoordinated actions' in isolation to protect (and expand) their corporate tax base, increasing the risk of double taxat
ion, and damaging cross-border trade and investment.
- In addition to policy reforms, reform of the global network of over 2000 bilateral tax treaties could also be considered. The current patchwork of bilateral treaties is arguably an important source for tax planning opportunities by multinational enterprises. As such, an institutional shift over time from bilateral to multilateral tax treaties could offer greater consistency between agreements, reducing tax planning opportunities and enabling the international tax architecture to be more responsive to developments in the economy and business practice.
- Last year the G20 called on the OECD to undertake a study of base erosion and profit shifting which resulted in the February 2013 report Addressing Base Erosion and Profit Shifting and the Action Plan.
- The Action Plan sets out a work program for addressing the key drivers of base erosion and profit shifting. Importantly this plan includes a strategy for providing non-OECD members with an opportunity to participate on an equal footing with member countries. A summary of the Action Plan is contained in
Australia should endorse the Action Plan which establishes a joint OECD and G20 project with a comprehensive work program to address the key drivers of base erosion and profit shifting.
- The difficulty of applying tax concepts developed in an industrial age has been recognised for some time (ATO, 1997). However, previous attempts to address these challenges have focused on how to adjust existing tax concepts to suit the digital economy. In part, this reflected the relatively small size of the digital economy at the time. However, it also reflected a limitation of ambition in order to achieve required multilateral consensus. As one article in 1999 commented:
Wide-ranging discussions of radical ideas such as the 'bit tax', and of the real meaning of the principles underlying international taxation have been discarded to enable us to focus on the serious business of implementing the agreed international agenda.
- The very significant growth in the size and the scope of the digital economy over the past decade requires reconsideration of this approach. In addition to rapid growth in electronic commerce in goods and services to consumers, the digital economy is increasingly affecting the traditional business models in a wide range of industries. The current international rules allocating taxing rights have been criticised as resulting in income generated in the digital economy (and from intangible assets generally) being allocated for tax purposes to neither the country where the intellectual property was developed nor the market in which intellectual property protection is provided (or some combination thereof).
- The OECD Action Plan recognises that a more holistic approach may be needed to address the tax challenges of the digital economy. It recognises that further analysis is needed for national governments to be in a position to consider specific reforms in this area. In particular, there is a need to better understand how the digital economy changes traditional views of the imposition and incidence of tax, and the pros and cons of different options to address these challenges. The OECD proposes that a taskforce would prepare a report on these issues by September 2014, which in turn would inform approaches on other elements of the Action Plan.
- Tax arbitrage opportunities in the form of hybrid mismatch arrangements can arise whenever economically equivalent entities, instruments or transfers are treated differently for tax purposes in two or more jurisdictions. The arrangements may lead to situations where there is double non-taxation or multiple uses of a particular loss or deduction amount; the arrangements in some circumstances exploit exemption rules as well as deferral rules which, when they allow for the long-term deferral of tax, effectively facilitate non-taxation.
- Hybrid entities include arrangements, such as limited partnerships, that have elements of both a corporate and non-corporate entity. A key issue for tax purposes is that taxation might be applied at the entity level in one country and at the investor level in another. In addition to opening the potential for tax planning opportunities (such as where a deduction is allowed in both jurisdictions) this can result in double taxation.
- Hybrid transfers (or synthetic transfers) are arrangements that result in the effective transfer of the risks and benefits associated with ownership of an asset without actually being a legal sale of the asset. This can present tax planning opportunities between (and within) jurisdictions, particularly where the transfer is recognised as a disposal or acquisition in one country and not another.
- Hybrid instruments typically refer to instruments that have characteristics of both debt and equity (such as redeemable preference shares). Tax planning opportunities arise for multinational enterprises where these instruments are treated as debt in one jurisdiction (with interest then allowed as a deduction) and equity in another (where typically the dividend is not subject to tax).
- The OECD Action Plan proposes action to neutralise the effects of hybrid mismatch arrangements. This could be achieved by changes to treaty practice through reforms to the OECD Model Tax Convention, as well as to domestic law provisions regarding certain types of exemptions and deductions. The OECD Action Plan specifically calls for addressing scenarios where exemption or non-recognition rules apply to the recipient of an amount when payments are deductible by the payor; where deductions are available for a payment that is not included in the assessable income of the recipient; and where deductions for the same amount are available in two jurisdictions. The OECD Action Plan also calls for coordination or tie-breaker rules when more than one country seeks to apply the rules to a particular transaction or structure; it also acknowledges the importance of coordinating the interaction between this action item and those on interest expense deductions, the Controlled Foreign Company (CFC) rules and treaty shopping.
- The fundamental differences in the tax treatment of debt and equity can influence the capital structure of multinational enterprises. Multinational enterprises have more flexibility than domestic enterprises in determining where international financing can occur and how debt will be allocated within the group. This flexibility can enable interest expenses to be shifted across the group, resulting in profit shifting for tax purposes. Similar flexibility exists with other financial payments.
- The OECD Action Plan proposes the development of best practice design guidelines in relation to rules to restrict excessive debt deductions, including where debt is used 'to finance the production of exempt or deferred income'. It will also develop further guidance on the pricing of related party financial transactions.
- Most developed economies have comprehensive 'transfer pricing' or cross-border 'profit allocation' rules. While the role of such rules is to protect the tax base from profit shifting, they perform other important roles for investors and trading partner governments in clarifying the rules for cross-border profit allocation, and broa
d parity between the tax treatment of multinational enterprises and businesses that operate entirely domestically.
- The relatively high degree of international consistency in transfer pricing rules has been overwhelmingly influenced by the work of the OECD. Transfer pricing rules typically use the principle of applying tax on the basis that related party arrangements had taken place between independent parties acting in their own commercial interests. Through this mechanism transfer pricing regimes seek to ensure that appropriate returns for the economic contribution made by operations in a particular jurisdiction are reflected in the tax base of that jurisdiction. The most difficult transfer pricing challenges have evolved from changes in the global business environment, driven by a range of factors including broader policy developments and technological advancement.
- Transfer pricing frameworks analyse where assets are located, where functions take place and where risks are assumed and managed. Current transfer pricing frameworks generally work well for the type of trade that existed when they were first developed. However, the rapid development of technologies has raised opportunities to centralise functions and harness efficiencies that multinationals in the most traditional of industries can now adopt. With these efficiency benefits also come tax planning opportunities.
- Such challenges arise where assets do not exist in any physical location or transit readily between jurisdictions, where activities or services can be effectively delivered from any location and where the mobility of assets and activities mean that the associated risk bearing and risk management is equally difficult to locate. These mobile and intangible factors of production are also among the most difficult to value.
- The OECD Action Plan includes specific action items to improve transfer pricing rules for hard to value intangibles, measures to address profit shifting opportunities arising out of the way risks are allocated amongst a multilateral group and high risk transactions that independent parties would not normally enter into. Other action items (such as in relation to excessive debt deductions) also have transfer pricing aspects. These categories closely mirror the most significant challenges Australia faces in area of transfer pricing.
- The OECD Action Plan proposes the development of model treaty provisions to limit the potential for tax treaties to be exploited to generate outcomes where there is double non-taxation. This will include the development of best practice guidelines on domestic rules countries could adopt to prevent treaty abuse, and policy considerations for countries to consider before entering into a tax treaty with another country.
- The concept of 'permanent establishment' is used to determine taxing rights over business profits derived in one country by a resident of another country. The underlying principle is that the presence should not be merely transitory. Under a tax treaty, the source country is permitted to tax business profits derived by a foreign resident to the extent that they are attributable to a permanent establishment located in the source country. However, both countries retain taxing rights over the income and assets of permanent establishments.
- The permanent establishment rules date back to a time when the bulk of economic activity took place at a physical location. The rise of the digital economy, which essentially has no physical location, led to changes to the guidance material to: include examples of when electronic commerce (such as electronic equipment), facilities such as cables or pipelines or agents are treated as a permanent establishment; exclude activities that were preparatory or auxiliary; and include alternative provisions that countries can use to allocate profits from the provision of services.
- Although these modifications have been made to adjust to the changing international environment, the changes have sought to 'shoehorn' the developments to fit within the pre-existing concepts. The net effect is that it is 'possible to be heavily involved in the economic life of another country … without having a taxable presence therein' (OECD, 2013, p. 7).
- In some cases, countries can modify their tax treaties to overcome some of these issues. For example, Australia seeks to include anti-contract splitting rules in its treaties to prevent manipulation of the time period thresholds that apply to treat certain building and construction and natural resource activities as a permanent establishment. However, tax treaties cannot overcome the fundamental issues that arise from operating in a digital economy.
- To ensure an appropriate share of tax revenues between jurisdictions is achieved in the changing environment and to prevent the artificial avoidance of permanent establishment status, the rules need to be modified. One option is to explore whether a better balance can be achieved by changing the rules so they rely on the level of economic activity rather than on a physical presence.
- The OECD Action Plan proposes to prevent the artificial avoidance of permanent establishment status, in particular through the use of 'Commissionaire arrangements' and other structures that exploit activities that are excluded from the permanent establishment definition. Essentially, under the permanent establishment definition, activities carried on through dependent agents are treated as permanent establishments whereas activities carried on through independent agents acting in the ordinary course of their business are not treated as permanent establishments. Commissionaire arrangements involve the interposition of agents (commissionaires) between sellers and purchasers of goods or services to exploit these rules and effectively negate the existence of a permanent establishment.
- CFC rules seek to protect against the use of related entities based in low or no tax jurisdictions to avoid tax by deeming certain types of income (including 'passive' income and income from some related party transactions) to be assessable in the parent company's jurisdiction typically on an accruals basis.27
- The February 2013 OECD report notes that in practice the CFC rules in many countries have not been as effective as intended, with examples of multinational enterprises being able to structure arrangements to inappropriately fall outside the scope of the rules. On the other hand, CFC rules have also been criticised as imposing disproportionately high compliance costs on business.
- The OECD Action Plan will develop recommendations to strengthen the design of CFC rules.
- The Forum on Harmful Tax Practices (the Forum) provides a framework that countries can use to identify and eliminate harmful tax regimes so as to create an environment in which free and fair tax competition can take place.
- The Forum period of time, reflecting the consensus approach of the OECD. Moreover, the Forum does not appear to have significantly limited the ability of multinational enterprises to shift income from 'mobile rents'. As such, it is questionable whether the criteria and processes used to determine whether a regime is harmful are adequate. For example, under the current definition of 'harmful tax practice', a regime that is considered potentially harmful may not have to be abolished or modified if the jurisdiction has in place effective arrangements for the exchange of information.
- Unlike the process used for the Global Forum on Transparency and Exchange of Information for Tax Purposes that has de
cisions reviewed by a peer review process, currently there are no procedures in place to review decisions made by the Forum. The Forum conducts a preliminary scan of member country regimes based on publicly available information. Relevant countries then undertake a self-assessment of the regimes identified by the Forum and provide advice to the Forum as to why or why not the regime might be considered harmful, with reference to the OECD's guidelines. Based on this work, together with referrals and self-reviews of regimes provided by delegates, the Forum on Harmful Tax Practices then decides whether a regime is considered harmful.
- The OECD Action Plan proposes a revamp of work on harmful tax practices, with a more holistic approach to evaluating regimes in the context of general concern about base erosion and profit shifting. It will focus on improving transparency and requiring substantial (real economic) activity in order for a preferential regime to not be regarded as harmful.
- The February 2013 OECD Report noted that a key challenge in assessing the level and growth of base erosion and profit shifting was the lack of agreed standards on the collection of data and appropriate metrics to use as a benchmark.
- The Action Plan will establish methodologies to collect and analyse data on base erosion and profit shifting, including recommendations on the development of indicators to monitor the scale and economic impact of base erosion and profit shifting over time.
- The Action Plan also includes several items aimed at supporting more effective and efficient compliance, including increased disclosure of 'aggressive tax planning arrangements', improving transfer pricing documentation to be more useful for tax authorities and less onerous on business, and improving the effectiveness of resolution of tax disputes between countries, particularly in relation to disputes over tax treaties.
20 See, for instance, submissions to the Issues Paper by PriceWaterhouseCoopers, Ernst &Young, and TD Bank, 2013, Submission to Issues Paper — Implications for the Modern Global Economy for the Taxation of Multinational Enterprises, May 2013.
21 The Minerals Council of Australia, 2013, Submission to Issues Paper – Implications for the Modern Global Economy for the Taxation of Multinational Enterprises, May 2013.
22 See US Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations 20 May 2013.
23 Tax Justice Network, Submission to the Issues Paper on Implications of the Model Global Economy for the Taxation of Multinational Enterprises, 31 May 2013.
25 Actions and proposals of other countries are summarised in
27 That is, it is an example of the application of a worldwide approach to taxation that is often combined as an anti-avoidance measure.