Ask the person in the street and you will be told that multinationals are rorting the tax system left, right and centre and nobody is doing anything about it. What that person possibly doesn't realise is there is a very powerful armoury of integrity rules which can be used by the Commissioner to counter international tax avoidance. In fact, there are so many integrity rules that are potentially relevant to any given transaction that there is a real issue as to overlap ‒ and potentially more tax disputes.
Recipe for increased tax controversy
It’s a classic recipe. Start with multinational taxpayers with high value transactions, throw in a handful of new and untested laws, each of which can potentially apply to the same fact pattern, and add a dash of political pressure ‒ all the ingredients for a significant increase in tax disputes.
Transactions undertaken by "significant multinationals" will potentially need to be run through the filter of several different integrity screens, including transfer pricing, the general anti-avoidance rules in Part IVA, the Multinational Anti-Avoidance Law (MAAL) and the new Diverted Profits Tax (DPT). In this context, "significant" means part of a global group with revenues exceeding AU$ 1 billion. Each of these rules is either brand new or has recently been overhauled ‒ inevitably meaning there will be uncertainty from both the ATO and taxpayers as to how the rules work individually and together as a co-ordinated integrity package.
If the ATO adopts the approach of asserting several different alternative grounds of assessment for a particular transaction or arrangement, the costs of defending the tax dispute will be high and the disputation timeline will almost certainly be extended.
The integrity rule overlap problem
To illustrate, consider the example where a US based group establishes a company in a tax haven (HavenCo) which owns an Australian subsidiary (AusCo). There are Australian customers who transact directly with HavenCo which derives sales income. AusCo provides marketing services which assists in the identification and engagement of customers and charges a fee for those services to a group company.
From a transfer pricing perspective, if HavenCo has no substance and all marketing and related functions to do with the sale are carried out by AusCo, then AusCo may be insufficiently rewarded by the off-shore company ‒ so an arm's length fee could be imputed under division 815.
Further, the ATO might assert under the transfer pricing reconstruction rules that the parties would not have entered into the actual arrangement at all in the way that they did. In that case, a reconstruction outcome may apply whereby AusCo is taken to acquire the relevant product and have on sold it to the customers. AusCo would be taken to derive a profit for tax purposes equal to that which an arm's length importer/distributor would have derived.
There is also a risk of the MAAL applying. If it does, then profits from Australian sales could be attributed to AusCo or a deemed permanent establishment of HavenCo with that attributed income subject to Australian tax at 30%.
The proposed DPT could also potentially apply, assuming that the tax payable in the haven jurisdiction is less than 80% of the Australian tax payable and that HavenCo has insufficient economic substance. This would result in the profits diverted to HavenCo through the understatement of the service fee derived by AusCo being subject to Australian tax at 40%. If the MAAL was also applied to attribute a tax liability to a deemed permanent establishment of HavenCo, an economic double tax liability could result.
General Part IVA
Further, if the arrangement was regarded as being entered into for the principal purpose of tax avoidance, it may well be that the general provisions of Part IVA also apply.
It doesn't make sense to apply all these rules to the same transaction ‒ so how do you know which regime to apply?
Transfer pricing will be a key focus
Transfer pricing rules should be the frontline integrity measure aimed at multinationals. The MAAL and DPT tend only to operate where there is an associated overseas party who is deriving income (at the expense of the Australian revenue) and lacks substance. But generally transfer pricing functional analysis in such cases will require an income allocation to Australia.
Transfer pricing rules are self-assessed (so the taxpayer must properly assess its own pricing decision), which means that the operation of the rules does not depend on the Commissioner making a determination. On the other hand, MAAL and DPT and general Part IVA rules all require a positive act on behalf of Commissioner before they apply. If there has been a mispricing, it seems difficult to see how the integrity rules could apply. There would not be any tax benefit ‒ there will simply have been a misapplication of the transfer pricing rules. As there is no tax benefit under the operative rule, the anti-avoidance rules have no scope to apply.
So in situations where transfer pricing rules apply there is less scope for the other integrity rules. The stated aim of a DPT (as noted in the Explanatory Memorandum) is to "encourage greater compliance by large multinational enterprises with their tax obligations". Notably, this would include the transfer pricing rules. This seems a confirmation that the rules were introduced in large part for political reasons, rather than to plug a genuine hole in the tax integrity system. Having said that, the gateway tests are different for each of the measures, so while there is going to be overlap, there will also be room for discrete operation independent of the transfer pricing rules. So it becomes rather confusing.
Stay tuned for critical ATO guidance
With the dust starting to settle, there will need to be some clear guidance from the ATO on how these rules are to be applied.
There will be a lot of pressure on the ATO getting its guidance right as a result of these new rules. The push to upfront guidance is motivated by a compliance regime where taxpayers are subject to early stage ATO pre-lodgement and risk reviews. If the ATO is going to look into your affairs upfront the ground rules need to be clear. Given that, and the overlap between regimes, the need for further guidance is obvious.
To its credit, the ATO recognises this need, and is doing a good job in trying to revisit how it delivers guidance and ensuring that it is provided on a timely basis. It's created some new guidance products, notably Law Companion Guidelines and Practical Compliance Guidelines. Helpful guidance was issued very promptly in relation to MAAL (LCG 2015/2) and there was recently transfer pricing guidance on marketing hubs (PCG 2017/1).
The ATO will need to continue to provide meaningful guidance to taxpayers ‒ otherwise the ever increasing web of complex tax rules will inevitably lead to confusion, uncertainty and a significant upswing in major tax disputes.