Australian Taxation Office's position on hybrid mismatch and US GILTI rules – opportunity to comment until 17 January 2020

27 Nov 2019

The Australian Taxation Office (ATO) has issued a draft taxation determination TD 2019/D12 (the Draft TD) on whether the United States "global intangible low taxed income" (GILTI) rules correspond to Australia’s "controlled foreign company" (CFC) rules in the Income Tax Assessment Act 1936 (ITAA 1936).

If adopted, the Draft TD could result in the loss of Australian tax deductions, effectively resulting in double taxation. Taxpayers should review how the Draft TD affects their tax position and consider making a submission by 17 January 2020.

The Draft TD's importance to Australian hybrid mismatch rules

The Draft TD is relevant to the application of Australian hybrid mismatch rules (hybrid mismatch rules).  These rules give effect to the OECD hybrid mismatch and branch mismatch rules from Action Item 2 of the OECD Base Erosion and Profit Shifting (BEPS) Action Plan.

The hybrid mismatch rules seek to neutralise the arbitrage opportunity arising where Australia, and one or more other countries, adopt a different tax treatment for (i) an entity, or (ii) a financial instrument, and that difference results in non-taxation of amounts or multiple tax deductions in respect of the same amount.

A key element to the application of the hybrid mismatch rules is determining whether an amount of income or profits is “subject to foreign income tax”. For example, this concept is relevant in identifying whether a payment gives rise to a deduction in Australia but with no income assessed in a foreign jurisdiction (deduction / non-inclusion (D/NI) mismatch), whether an amount of income is assessed in more than one jurisdiction (dual inclusion income) (this can mitigate the adverse impact of the hybrid mismatch rules) or whether “integrity rules” apply.

The ATO conclusion: no correspondence with controlled foreign company rules

The Draft TD adopts the position that the GILTI rules – specifically section 951A of the Internal Revenue Code – do not correspond to the Australian CFC rules and therefore do not cause an amount of income or profits to be "subject to foreign income tax" for the purposes of the hybrid mismatch rules. This conclusion could have the effect of denying Australian tax deductions where the relevant payment is nonetheless taxable in the US.

Australian legislative context

Section 832-130 of the Income Tax Assessment Act defines the words "subject to foreign income tax" and extends that meaning to where to a foreign country’s laws which correspond with Australia’s CFC regime incorporate an amount in that foreign country's tax base. Specifically, subsection 832-130(5) states:

"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)."

Broadly, the CFC regime applies to tax Australian resident shareholders in a CFC on an accruals basis on certain "tainted income" of a CFC (including interest, rent, royalties and amounts arising from certain related party transactions). Tainted income is distinguished from “active income” (broadly, income from active business activity and involving unrelated third parties), which is typically not subject to the CFC rules. Sections 456 and 457 are the "charging" provisions for the CFC rules.

The ATO's rationale in the Draft TD

The ATO states in the Draft TD that section 951A of the US Internal Revenue Code does not "correspond to" sections 456 and 457 of the ITAA 1936. This is on the basis that sections 456 and 457 are inclusion provisions for a general anti-deferral regime and there is no equivalent to the US GILTI rules in Australia (a rule which the ATO considers to be a global minimum tax regime).

Consequently, income that is within the scope of GILTI rules is not relevant to the identification of whether a payment gives rise to a D/NI mismatch, whether there is dual inclusion income or whether the “integrity rules” apply.

In the Draft TD, the ATO outlines what it considers to be the key differences between the regimes:

GILTI rules, section 951A CFC rules, sections 456 and 457
Reflective of section 951A functioning as the inclusion provision for a global minimum tax regime, a GILTI inclusion under section 951A is determined on an aggregate CFC basis. In contrast, sections 456 and 457 (not being inclusion provisions for a global minimum tax regime) operate on a CFC by CFC basis.
GILTI is a different category of income to subpart F income and is determined in a way that is fundamentally different to determining subpart F income. In substance, a GILTI inclusion under section 951A represents a deemed high or above-normal return on certain depreciable property whether or not the deemed return in fact comprises passive or tainted income and whether or not the deemed return in fact comprises intangible income. In contrast, an inclusion under section 456 or 457 does not represent a deemed high or above-normal return on depreciable property. Sections 456 and 457 require that there be an amount of attributable income or adjusted distributable profits, both of which fundamentally comprise actual passive or tainted income and irrespective of whether that income represents a below-normal, normal or above-normal return.

Responding to the Draft TD

As the Draft TD has retrospective effect (which can mean it applies from as early as 1 January 2019), taxpayers who have considered, or are considering, the impact of the GILTI rules on their Australian tax position should carefully review the Draft TD.

If you wish to provide comment on the Draft TD you will need to do so by 17 January 2020 as this will likely be the final opportunity to be able to have a say on the form of tax determination which is ultimately adopted.

If you would like any help in understanding the impact of the ATO's position on your Australian tax profile or in making a submission, please contact us.

Thanks to my colleague, Mick Blanco, for his help in writing this Alert.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.