On 23 June 2023, Treasury released further draft legislation to deny deductions for payments by Significant Global Entities (SGEs) relating to intangible assets connected with low corporate tax jurisdictions (Exposure Draft Bill).
The anti-avoidance measure applies to deny deductions on or after 1 July 2023 where:
Doubled penalties will apply (in addition to the doubled penalties that apply to SGEs).
Given the broadness of the scope of the proposed legislation, coupled with it applying to existing arrangements and noting the significant penalty implications, it would be prudent for SGEs to act now in reviewing their arrangements.
The Exposure Draft Bill amends the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) to include a new anti-avoidance rule to deter SGEs from avoiding corporate income tax and withholding tax by structuring their arrangements so that income from exploiting intangible assets is derived from low corporate tax jurisdictions.
The Exposure Draft Bill follows the October 2022 Federal Government announcement and an earlier exposure draft released in March 2023 for consultation.
Some of the feedback received by Treasury from the consultation process has been taken into account in this new Exposure Draft Bill and accompanying Explanatory Memorandum (EM).
Overall the design of the proposed legislation remains incredibly broad. The surprise feature in this new Exposure Draft Bill is the Governmental position on penalties, which effectively quadruples the base penalty amount. This aspect is particularly concerning given the broadness of the scope of the proposed legislation and the notable absence of a purposive element (which is an important counterweight that features in other anti-avoidance provisions).
The new law is intended to apply to existing structures as well as to deter new structures.
Changes in the new Exposure Draft Bill include modifications, which reflect feedback as part of the consultation process. As an example, for the purposes of determining whether income is derived by an associate in a low corporate tax jurisdiction from the exploitation of an intangible asset, the following income is disregarded, to the extent that the income:
Defined broadly and includes using, marketing, selling, licensing or distributing the intangible asset.
The amendments apply to a permission to exploit an intangible asset, and thus will apply where the ability to exploit the intangible asset is implied via the conduct of, or an understanding between, the related parties.
Examples of activities considered to be within the meaning of exploiting an intangible asset are:
Adopts the broad definition in s 995-1(1) of the ITAA 1997 and includes:
In addition, the provision requires that the SGE or associate acquires the intangible asset, the right to exploit, or actually exploits the intangible asset, as a result of the arrangement under which the payment is made.
This is an objective test which will require an examination of the whole arrangement, including collateral contracts and legally unenforceable understandings between the parties. It will apply to situations where the SGE or other entity does not acquire any express right to exploit the intangible asset under an arrangement providing for the payment, but, as a result of a common understanding, has access to intangible assets. The EM also makes it clear that it is not necessary that the payment and acquisition of the right to exploit or exploitation of an intangible asset is provided for in the same contract.
Payments can be made by an SGE directly, or through one or more other entities to an associate. A strict tracing through the flow of funds is not required.
The amendments apply to deny deductions to the extent that the payment is attributable to the right to exploit the intangible asset. It will capture circumstances where a payment might purportedly be made for things, such as services or tangible goods, but the arrangement also results in the exploitation of an intangible asset (regardless of whether it is stated in the written contract that the payment is for services or a tangible good).
The phrase takes its ordinary meaning, and it is not intended that the term adopt a definition specifically used for accounting or transfer pricing purposes.
Examples include intellectual property, copyright, information or data (including a database of customers), algorithms, software licenses, licenses, trademarks, patents and leases, licences or other rights over assets.
Carved out of the definition is tangible assets, interests in land and certain financial arrangements.
An additional exclusion is genuine supply and distribution agreements. For example, where trade marks are printed on finished goods that are marketed and sold by an SGE to customers, the anti-avoidance rule will not apply to deny a deduction to the extent that the payment made by the SGE to an associate is genuinely attributed to the good and not the trademark.
A foreign country will be a low corporate tax jurisdiction if the rate of corporate income tax is less than 15% or nil.
It is the national headline corporate income tax that is relevant for the purposes of determining whether a jurisdiction is a low corporate tax jurisdiction. Any concessional rate of income tax that could apply in the foreign country is not relevant to the definition.
For countries with progressive corporate income tax rates, only the highest rate will be relevant. However, state and municipal income taxes will be aggregated to determine the rate of corporate income tax applied.
In determining if income has been derived in a low corporate tax jurisdiction by an associate, income, to the extent that it has been taken into account and assessed as attributable income under the Australian CFC regime is disregarded. In addition, to the extent that any amount of income is subject to foreign tax of at least 15 per cent, that amount of income is also disregarded.
The amendments will also apply to deny deductions for payments to associates where income from exploiting the intangible asset is derived in a jurisdiction determined by the Minister as providing for preferential patent box regime without sufficient economic substance.
The Exposure Draft Bill proposes that where a deduction would otherwise be denied because of the operation of the amendments, but the taxpayer has withheld an amount from a royalty payment and remitted it to the Commissioner, and no other provision denies a deduction, the amount of the deduction denied will be reduced to reflect the withholding tax paid.
The Exposure Draft Bill also contains a doubling of the base penalty amounts (in addition to the doubling that already applies to an SGE). A snapshot of these increased penalties are below:
The broad application of the new rule means that SGEs will need to carefully consider their arrangements immediately given the provisions are proposed to commence on 1 July 2023.
Under the new rule, deductibility will turn upon the concept of whether the payment is “attributable to” the exploitation of the intangible asset. To the extent that the payment is attributable to other rights or things other than the exploitation of the intangible asset, there may be a basis for the deduction (as to that part).
In order to ascertain whether and to what extent the payment by an SGE to an associate is attributable to the exploitation of an intangible asset, it may be useful to undertake the following evaluative steps:
For additional information with respect to this insight, please contact us.
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