Australian Federal Budget 2024: key taxation matters for large business and investors

What does the Federal Budget mean for corporate taxpayers? Now that everyone has had time to wade through the media reporting, we bring you our commentary.

Multinational groups and foreign investors should take note of the announced measures designed to reduce perceived leakages from the Australian tax base as there may be an impact on their arrangements and dealings with Australia. Those with an interest in critical minerals and renewables may be interested in the proposed tax incentives. We discuss some of the more notable aspects of the 2024-25 Budget below.

Intangible assets and royalty withholding tax

Denying deductions for payments relating to intangibles held in low- or no- tax jurisdictions will no longer proceed

The Government has announced that it will no longer proceed with the introduction of the measure Denying deductions for payments relating to intangibles held in low or no tax jurisdictions announced in the 2022–23 October Budget. This measure was intended to deter large multinationals (i.e. significant global entities (SGEs)) from holding and exploiting their intangible assets in low-tax jurisdictions. Had the measure proceeded, SGEs would have been prevented from claiming deductions for payments made to related entities in low-tax jurisdictions that are attributable to the exploitation of an intangible asset.

The reason for the measure no longer proceeding is that the perceived mischief will now be addressed through Australia’s proposed Domestic Minimum Tax, which forms part of Australia’s response to BEPS Pillar 2. Nevertheless, this announcement is welcome as it at least addresses concerns that inconsistencies between the proposed denial rule and certain design features under the domestic minimum tax measure could have resulted in a higher effective tax rate than 15 per cent for some taxpayers.

New penalty for mischaracterised or undervalued royalty payments

One unexpected – but perhaps unsurprising – announcement was that the Government will introduce a new penalty that will apply where an SGE mischaracterises or undervalues royalty payments which are (or would otherwise be) subject to royalty withholding tax. Other than the start date of 1 July 2026, no other details about how the penalty will operate have been announced.

The royalty withholding tax provisions are currently out of the scope of the administrative penalty regime in relation to the making of a false or misleading statement that gives rise to a shortfall.

The announcement of this measure is unsurprising, in that it aligns with the current focus of the Australian Taxation Office (ATO) on intangible assets and its strategic litigation on this topic that is currently playing through in the Federal Court. It will also be interesting to see how this measure interacts with the announcement in last year’s Budget to expand the scope of Part IVA to apply to schemes that reduce tax paid in Australia by accessing a lower withholding tax rate on income paid to foreign residents (which has now been delayed until on or after 1 July 2024 or the date the amending legislation receives royal assent).

It will be interesting to see whether the penalty will align with the usual base penalty amount percentages referable to culpable behaviour (25 per cent through to 75 per cent), whether there will be an uplift for SGEs, or whether the penalty regime will adopt a similar approach to the diverted profits tax regime (which imposes tax at a penalty tax rate of 40 per cent). 

Thin capitalisation

The thin capitalisation regime was recently amended, following on from previous budget announcements, with the new legislation being enacted on 8 April 2024 (but which applies to income years beginning on or after 1 July 2023).

The Government has stated that Australian plantation forestry entities are to be exempted from the new earnings-based thin capitalisation regime. This means that entities that qualify for the exemption will be allowed to continue to apply the former asset-based thin capitalisation rules alongside authorised deposit taking institutions. This measure has already been given effect.

While not a Budget announcement per se, the ATO had announced on 10 May 2024 that it will develop public advice and guidance (PAG) as a matter of priority on the following practical matters arising under the new thin capitalisation regime:

1. Guidance on the application of the general anti-avoidance rule (Part IVA) and/or the Debt Deduction Creation Rules to certain restructures in response to the new law;
2. Interpretive guidance on key concepts in the third-party debt test such as “minor or insignificant”; and
3. Compliance guidance to explain the ATO’s approach to the interaction of the transfer pricing rules and the new thin capitalisation rules (such as the interaction with PCG 2017/4).

The ATO announcement also contained a list of other issues that may be considered for PAG following the completion of the high-priority items, including guidance on the calculation of tax EBITDA (including disregarded amounts) and documentation requirements (see, ‘Amendments to the Thin Capitalisation rules – ATO's PAG consultation topics and prioritisation’).

Investing in a “Future Made in Australia” – new tax incentives

As part of its Future Made in Australia package, the Government has announced that it will establish two new tax incentives, which are intended to encourage investment in Australia’s critical minerals and hydrogen processing industries. These are the Critical Minerals Production Tax Incentive and the Hydrogen Production Tax Incentive.

The Critical Minerals Production Tax Incentive aims to support downstream refining and processing of Australia’s critical minerals and improve supply chain resilience. This incentive will be available for up to 10 years per project from 1 July 2027 until 30 June 2040 and be delivered in the form of a refundable tax offset equal to 10 per cent of eligible critical mineral processing costs. The tax offset is to be available in relation to all 31 of the critical minerals listed on Australia’s critical minerals list, which includes rare earths elements, such as lithium, nickel, cobalt and silicon. The Government will consult on what processing costs will be eligible for the offset.

The Hydrogen Tax Incentive is intended to support Australian producers of renewable hydrogen. This incentive will also be available for up to 10 years per project from 1 July 2027 until 30 June 2040, for projects that reach final investment decisions by 2030. This incentive is to be delivered in the form of an uncapped refundable tax offset. While the ATO has stated that the amount of the incentive will be subject to consultation, the Prime Minister has announced that the incentive will be worth A$2 per kilogram of renewable hydrogen produced.

We are hopeful that Treasury releases further details regarding these incentives – together with the eligibility criteria – with sufficient time, so as to enable project planning commensurate with the intended policy objective.

Capital gains tax for foreign residents

The Government has announced that it will enact measures to “strengthen” Australia’s foreign resident capital gains tax (CGT) regime to “ensure foreign residents pay their fair share of tax … and to provide greater certainty” for CGT events happening on or after 1 July 2025.

Broadly, Australia’s current foreign resident CGT regime seeks to impose capital gains tax on non-residents disposing of:

• direct or indirect interests in Australian real property (that is, taxable Australian real property (TARP) and indirect Australian real property interests); or
• assets used in the non-resident’s Australian permanent establishment.

The concept of TARP includes not only real property situated in Australia, but also leases of Australian land, as well as mining, quarrying or prospecting rights over resources situated in Australia. Broadly, indirect Australian real property interests are membership interests (e.g. shares), the underlying value of which are principally derived from TARP assets assessed at the time of disposal / the CGT event. This assessment of underlying value is known as the principal asset test.

The Government states that its proposed reforms will increase certainty for foreign investors by more closely aligning Australia’s foreign resident CGT regime with OECD standards and practice. The amendments that have been announced are to:

• clarify and expand the range of assets on which foreign residents are subject to CGT;
• modify the principal asset test from a point-in time to a 365-day testing period; and
• require foreign residents disposing of shares or other membership interests worth more than A$20 million to notify the ATO before the transaction is executed.

In relation to the first measure, the Government has stated that the intention of the measures is to allow Australia to tax non-residents on disposals of “assets with a close economic connection with Australian land”.

The question of whether an asset is TARP, and the approach to valuation has been the subject of controversy over many years, and is a live issue currently before the courts in a mining context. We watch with interest to see how far this broadening of the foreign resident tax base will extend and how the concept of “close economic connection” interacts with the concept of real property, that being the concept that is applied in Australia’s tax treaties.

The principal asset test currently includes an integrity rule to prevent the outcome of the test from being manipulated by an entity acquiring non-TARP assets. Modifying the principal asset test from a point-in-time test to a 365-day testing period is likely being introduced as another integrity measure. What is unclear is whether the amendment will result in membership interests being treated as indirect Australian real property interests if the principal asset test is satisfied at any point in time during the testing period or whether there will be some form of averaging over that period and whether taxpayers will now be faced with having to obtain multiple market valuations of their assets.

Finally, the requirement for foreign residents to notify the ATO of any disposal of membership interests over A$20 million is significant. Unfortunately, no details about how this requirement is intended to operate in practice have been provided yet. For example, the announcement does not clarify whether all disposals of membership interests by non-residents will need to be reported, or whether just disposals which the foreign resident has assessed as falling outside Australia’s CGT regime.

Further, in addition to the A$20 million threshold for notification being very low, it is not clear what, if any, degree of connection between the transaction and Australia must exist before the obligation to notify is enlivened. For example, does a multinational group have an obligation to notify the ATO of an internal group restructure outside of Australia merely because of the existence of a dormant Australian entity within the restructure group?

While currently framed as a notification (and not approval) requirement, the requirement for notification to be made before a transaction is executed suggests that the ATO intends to use these notifications as a tool for identifying transactions for ATO interventions such as garnishee or asset freezing orders. Accordingly, this new measure not only introduces an additional implementation step into transactions but has the potential to disrupt transactions as well.

Concluding comments

We don’t yet have further details about the proposed legislative instruments to give effect to these announcements. The Government continues to pursue its agenda aimed at multinationals and “ensuring that they are paying their fair share of tax”. Consistent with recent observed practice, we expect greater scrutiny of multinationals and foreign investors, particularly in relation to transactions involving internal reorganisations, pre-sale restructuring, related party financing arrangements and migrating intellectual property to offshore related parties in overseas jurisdictions with effective low taxation.

If you have any questions or comments about the how the above measures might affect your business, please contact Annemarie Wilmore or Julian Wan from the JWS Tax team.