Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Scott Morrison MP)

Chapter 1 - Diverted profits tax

Outline of chapter

1.1 Schedule 1 to this Bill amends the ITAA 1936, the TAA 1953 and associated Acts to introduce a new DPT. If the DPT applies, the Diverted Profits Tax Act 2017 will impose tax on the amount of the diverted profit at a rate of 40 per cent.

1.2 The DPT aims to ensure that the tax paid by significant global entities properly reflects the economic substance of their activities in Australia and aims to prevent the diversion of profits offshore through contrived arrangements. It will also encourage significant global entities to provide sufficient information to the Commissioner to allow for the timely resolution of tax disputes.

Context of amendments

1.3 The DPT will provide the Commissioner with extra powers to deal with taxpayers who transfer profits to offshore associated entities using arrangements entered into or carried out for a principal purpose of avoiding Australian tax.

1.4 Australia's anti-avoidance and transfer pricing rules, already amongst the strongest in the world, will be bolstered by the DPT which will be inserted into Part IVA of the ITAA 1936.

1.5 By making it easier to apply Australia's anti-avoidance provisions and applying a 40 per cent rate of tax, which will need to be paid immediately to the Commissioner, the DPT will:

•

complement the application of the existing anti-avoidance rules in Part IVA of the ITAA 1936;

•

encourage greater compliance by large multinational enterprises with their tax obligations in Australia, including with Australia's transfer pricing rules in Division 815 of the Income Tax Assessment Act 1997 (ITAA 1997); and

•

encourage greater openness with the Commissioner, address information asymmetries and allow for quicker resolution of disputes.

1.6 The DPT will apply to large multinationals (significant global entities with annual global income of $1 billion or more) with total assessable income, exempt income and non-assessable non-exempt income of more than $25 million with schemes that involve associated entities that do not have the economic substance to justify their income.

1.7 By changing the payment and appeal processes in these situations and supporting the Commissioner to act on limited information, the DPT will encourage taxpayers to be more transparent and cooperative with the Commissioner. In many cases this will enable an agreed outcome to be reached with the Commissioner under the existing taxation provisions during a 12 month period of review.

1.8 Similar to the previously enacted multinational anti-avoidance law, the DPT will apply a lower threshold test, making it easier to apply Australia's anti-avoidance provisions. This lower threshold is aligned with Organisation for Economic Co-operation and Development (OECD) guidance on anti-abuse rules for international tax treaties. While not expanding the coverage of the corporate tax base, this will make it easier for the Commissioner to apply anti-avoidance provisions to the situations targeted by the DPT.

Summary of new law

1.9 Schedule 1 to this Bill introduces the DPT to ensure that large multinationals are not able to avoid their Australian tax obligations by diverting profits generated in Australia offshore.

1.10 The primary objects of the DPT are:

•

to ensure that the Australian tax payable by significant global entities properly reflects the economic substance of the activities that those entities carry on in Australia;

•

to prevent those entities from reducing the amount of Australian tax they pay by diverting profits offshore through contrived arrangements between related parties; and

•

to encourage significant global entities to provide sufficient information to the Commissioner to allow the timely resolution of disputes about Australian tax.

1.11 The DPT will apply to a scheme, in relation to a tax benefit (the DPT tax benefit) if, broadly:

•

a taxpayer (a relevant taxpayer) has obtained, or would but for section 177F obtain, the DPT tax benefit in connection with the scheme in an income year;

•

it would be concluded (having regard to certain matters) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a principal purpose of, or for more than one principal purpose that includes a purpose of:

-

enabling the relevant taxpayer to obtain a tax benefit, or both to obtain a tax benefit and reduce a foreign tax liability; or

-

enabling the relevant taxpayer and another taxpayer (or other taxpayers) to obtain a tax benefit, or both to obtain a tax benefit and reduce a foreign tax liability;

•

the relevant taxpayer is a significant global entity for the income year;

•

a foreign entity that is an associate of the relevant taxpayer is the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme, or is otherwise connected with the scheme or any part of the scheme;

•

the relevant taxpayer is not one of the following types of entities:

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a managed investment trust;

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a foreign collective investment vehicle with a wide membership;

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a foreign entity owned by a foreign government;

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a complying superannuation entity; or

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a foreign pension fund; and

•

if it is reasonable to conclude that none of the following tests applies in relation to the relevant taxpayer, in relation to the DPT tax benefit:

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the $25 million income test

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this test will apply if it is reasonable to conclude that, broadly, the sum of the assessable income, exempt income and non-assessable non-exempt income of the relevant taxpayer, the assessable income of any other associated entities that are members of the same global group and, if the DPT tax benefit relates to an amount not being included in assessable income, the amount of the DPT tax benefit, does not exceed $25 million;

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the sufficient foreign tax test

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this test will apply if, broadly, the increase in the foreign tax liabilities of foreign entities resulting from the scheme is 80 per cent or more of the reduction in the Australian tax liability of the relevant taxpayer; or

-

the sufficient economic substance test

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this test will apply if, broadly, the profit made as a result of the scheme by the relevant taxpayer and by each entity that is an associate of the relevant taxpayer and entered into or carried out the scheme or any part of the scheme, or is otherwise connected with the scheme or any part of the scheme, reasonably reflects the economic substance of the entity's activities in connection with the scheme.

1.12 If Part IVA of the ITAA 1936 applies to a scheme because of section 177J, the Commissioner may issue a DPT assessment to the relevant taxpayer and the Diverted Profits Tax Act 2017 will impose tax on the amount of the diverted profit at a penalty tax rate of 40 per cent.

1.13 Where the Commissioner makes a DPT assessment, the taxpayer will have 21 days to pay the amount set out in the DPT assessment.

1.14 Following the issue of the notice of a DPT assessment, the taxpayer will be able to provide the Commissioner with further information disclosing reasons why the DPT assessment should be reduced (in part or in full) during the period of review (generally 12 months after notice is given of the DPT assessment).

1.15 If, at the end of that period of review, the relevant taxpayer is dissatisfied with the DPT assessment, or the amended DPT assessment, the taxpayer will have 60 days to challenge the assessment by making an appeal to the Federal Court of Australia. However, the taxpayer will generally be restricted to adducing evidence that was provided to the Commissioner before the end of the period of review.

Comparison of key features of new law and current law

Detailed explanation of new law

1.16 Schedule 1 to this Bill introduces the DPT aimed at ensuring that large multinationals are not able to avoid their Australian tax obligations by diverting profits generated in Australia offshore. This Chapter outlines:

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the circumstances in which the DPT applies to a taxpayer;

•

the consequences that arise if the DPT applies to a taxpayer; and

•

the DPT assessment and review process.

Circumstances in which the DPT will apply

1.17 The DPT is being inserted into Part IVA of the ITAA 1936. Part IVA, which applies to schemes to reduce income tax, was amended in 2013 (see Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013). The Explanatory Memorandum for the amending Bill states (at paragraph 1.9 and 1.10) that:

Part IVA was enacted in 1981 to overcome deficiencies that judicial decisions had exposed in the operation of the previous general anti-avoidance provision - section 260 of the ITAA 1936.

The explanatory memorandum accompanying Part IVA explained that Part IVA was 'designed to overcome' the difficulties with section 260 and 'provide - with paramount force in the income tax law - an effective general measure against those tax avoidance arrangements that inexact though the words may be in legal terms are blatant, artificial or contrived' (see explanatory memorandum, Income Tax Laws Amendment Bill (No 2) 1981).

1.18 The DPT, like the multinational anti-avoidance law, expands the scope of Part IVA and is still focused on tax avoidance arrangements that are of an artificial or contrived nature. Although the DPT is not a provision of last resort, consistent with the operation of Part IVA, it is expected that the DPT will be applied only in very limited circumstances. It is intended that the Commissioner would apply the DPT only after he or she has given consideration to the operation of the ordinary provisions in the income tax law.

Objects of the DPT

1.19 The primary objects of the DPT provisions (that is, sections 177H to 177R of the ITAA 1997) are:

•

to ensure that the Australian tax payable by significant global entities properly reflects the economic substance of the activities that those entities carry on in Australia; and

•

to prevent those entities from reducing the amount of Australian tax they pay by diverting profits offshore through contrived arrangements between related parties.

[Schedule 1, items 6 and 13, definition of 'DPT provisions' in subsection 177A(1) and subsection 177H(1) of the ITAA 1936]

1.20 In addition, the DPT provisions, in combination with Division 145 in Schedule 1 to the TAA 1953, have the object of encouraging significant global entities to provide sufficient information to the Commissioner to allow the timely resolution of disputes about Australian tax.

[Schedule 1, item 13, subsection 177H(2) of the ITAA 1936]

When will the DPT apply?

1.21 The DPT will apply to a scheme, in relation to a tax benefit (the DPT tax benefit) if, broadly:

•

a taxpayer (the relevant taxpayer) has obtained, or would but for section 177F obtain, the DPT tax benefit in connection with the scheme in an income year;

•

it would be concluded (having regard to the matters in subsection 177J(2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a principal purpose of, or for more than one principal purpose that includes a purpose of:

-

enabling the relevant taxpayer to obtain a tax benefit, or both to obtain a tax benefit and reduce a foreign tax liability; or

-

enabling the relevant taxpayer and another taxpayer (or other taxpayers) to obtain a tax benefit, or both to obtain a tax benefit and reduce a foreign tax liability;

•

the relevant taxpayer is a significant global entity for the income year;

•

a foreign entity that is an associate (as defined in section 318 of the ITAA 1936) of the relevant taxpayer is the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme, or is otherwise connected with the scheme or any part of the scheme;

•

the relevant taxpayer is not one of the following types of entities:

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a managed investment trust;

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a foreign collective investment vehicle with wide membership;

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an entity owned by a foreign government that is a foreign entity;

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a complying superannuation entity; or

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a foreign pension fund; and

•

if it is reasonable to conclude that none of the following tests applies in relation to the relevant taxpayer, in relation to the DPT tax benefit:

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the $25 million income test (section 177K);

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the sufficient foreign tax test(section 177L); or

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the sufficient economic substance test (section 177M).

[Schedule 1, items 6 and 13, definition of 'DPT tax benefit' in subsection 177A(1), subsection 177J(1), sections 177K, 177L and 177M of the ITAA 1936]

The DPT applies in relation to a scheme

1.22 For the DPT to apply there must be a scheme. A scheme is defined in section 177A of the ITAA 1936 to mean:

•

any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

•

any scheme, plan, proposal, action, course of action or course of conduct.

1.23 The DPT can apply whether or not the scheme has been or is entered into or carried out:

•

in Australia;

•

outside Australia; or

•

partly in Australia and partly outside Australia.

[Schedule 1, item 13, subsection 177J(7) of the ITAA 1936]

The relevant taxpayer must obtain a tax benefit in connection with the scheme

1.24 For the DPT to apply to a scheme in relation to a DPT tax benefit, the relevant taxpayer must obtain, or would but for section 177F obtain, the DPT tax benefit in connection with the scheme in an income year.

[Schedule 1, item 13, paragraph 177J(1)(a) of the ITAA 1936]

1.25 A tax benefit is defined in section 177C of the ITAA 1936 and is a core concept within Part IVA. The primary objective of the amendments to Part IVA that were made in 2013 was to clarify the bases for identifying tax benefits (see Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2015). The Explanatory Memorandum for the amending Bill states (at paragraph 1.27) that:

The purpose and function of section 177C is to define the kind of tax outcomes that a participant in the scheme must have had the purpose of securing for the taxpayer, and which must have been secured in connection with the scheme, if Part IVA is to apply.

1.26 That Explanatory Memorandum, together with Australian Taxation Office (ATO) Practice Statement Law Administration PS LA 2005/24, contains detailed comments about the bases for identifying tax benefits.

1.27 The calculation of a tax benefit requires consideration of a reasonable alternative postulate. That is, it requires identifying the tax outcome that would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out. This necessitates that the tax outcomes arising from reasonable alternative postulate are determined with reference to the ordinary provisions in the income tax law, including, where relevant, the application of the transfer pricing rules to determine arm's length conditions.

1.28 Section 177C specifies a range of tax benefits that can be obtained under the Australian income tax law. For DPT purposes, the most common tax benefits that are likely to arise in relation to a scheme are:

•

a tax benefit relating to the understatement of assessable income; or

•

a tax benefit relating to the overstatement of a deduction.

Example 1.1

The Commissioner has identified a scheme that involves Australia Co borrowing A$100 million from a foreign associate, Foreign Co, at an interest rate of 8 per cent. Foreign Co is a resident of a country with a corporate tax rate of 15 per cent.

Foreign Co has sourced the loan funds by way of an A$100 million loan from Parent Co (who is resident of a country with a corporate tax rate of 28 per cent). Foreign Co pays Parent Co an interest rate of 5 per cent, which is priced in accordance with arm's length principles.

Foreign Co does not undertake any economically significant functions in relation to the loan arrangements, does not undertake a treasury function for the group and there does not appear to be any commercial reason why Australia Co did not borrow directly from Parent Co.

In considering whether the DPT can apply, the Commissioner concludes that the alternative postulate would be that Australia Co would have borrowed the A$100 million directly from Parent Co.

Australia has a double tax treaty with both foreign jurisdictions in which Parent Co and Foreign Co are resident, and as such the withholding tax on interest payments on the loan would be 10 per cent under both the scheme and the reasonable alternative postulate.

Therefore, the tax benefit is the 3 per cent differential in interest rates between the deduction claimed under the scheme and the deduction that would have been available under the reasonable alternative postulate.

Example 1.2

The facts are the same as in Example 1.1 except that:

•

Australia Co pays Foreign Co an interest rate of 5 per cent on the A$100 million loan

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the 5 per cent interest rate is priced in accordance with arm's length principles;

•

Foreign Co pays Parent Co an interest rate of 8 per cent on the A$100 million loan; and

•

the funding arrangements between Parent Co and Foreign Co are structured so that they achieve a foreign tax benefit for Parent Co.

Assuming the same reasonable alternative postulate as in Example 1.1, being that Australia Co would have borrowed directly from Parent Co, the interest deduction under the scheme is lower than what would have been the deduction under a reasonable alternative postulate. Therefore, notwithstanding the different corporate tax rates between the two foreign jurisdictions and the obtaining of a foreign tax benefit, there is no Australian tax benefit to which the DPT will apply.

1.29 For the purposes of the DPT provisions, the amount of a DPT tax benefit may be modified if:

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the thin capitalisation provisions apply to the relevant taxpayer for the income year; or

•

the foreign entity is a controlled foreign corporation.

1.30 The thin capitalisation modification, which preserves the role of Division 820 of the ITAA 1997 in respect of its application to an entity's amount of debt, applies if:

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the thin capitalisation provisions (Division 820 of the ITAA 1997) apply to the relevant taxpayer for the relevant income year;

•

the DPT tax benefit includes all or part of a debt deduction (within the meaning of the ITAA 1997); and

•

the calculation of the amount of the DPT tax benefit involves applying a rate to a debt interest (within the meaning of the ITAA 1997).

[Schedule 1, item 13, subsection 177J(4) of the ITAA 1936]

1.31 In these circumstances, for the purposes of calculating the amount of the DPT tax benefit, the rate should be applied to the debt interest actually issued (rather than to the debt interest that would have existed if the scheme had not been entered into or carried out).

[Schedule 1, item 13, subsection 177J(5) of the ITAA 1936]

1.32 Debt deductions (as defined in section 820-40 of the ITAA 1997) include any costs directly incurred in obtaining or maintaining a debt interest for example, interest or amounts in the nature of interest, guarantee fees, line fees and discounts on commercial paper.

1.33 The thin capitalisation modification will operate as follows.

•

First, consider if the DPT tax benefit includes (in total or as part of the tax benefit) a debt deduction. If it does, determine the debt interest that would have been issued and the rate that would have applied had the scheme not been entered into or carried out.

•

Second, modify the calculation of the DPT tax benefit so that the rate for a particular debt interest is applied to the actual amount of debt for that debt interest.

1.34 The foreign entity controlled foreign corporation modification applies if:

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the relevant foreign entity is a controlled foreign corporation (within the meaning of Part X of the ITAA 1936); and

•

an amount of attributable income (within the meaning of that Part) of the foreign entity has been included, because of the operation of that Part, in the assessable income of:

-

the relevant taxpayer; or

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an associate (within the meaning given by section 318 of the ITAA 1936) of the relevant taxpayer where the associate is an Australian resident (within the meaning of Part X) and is not a trust or partnership.

[Schedule 1, item 13, subsection 177J(6) of the ITAA 1936]

1.35 When the modification applies, the DPT tax benefit is reduced to the extent that the amount is included in assessable income as a result of the scheme and is directly referable to the DPT tax benefit.

[Schedule 1, item 13, subsection 177J(6A) of the ITAA 1936]

1.36 This modification ensures that the DPT tax benefit is reduced to the extent an amount of attributable income has given rise to, for example, an increase in an amount of a partner's assessable income in respect of an interest in the net income of the partnership, an increase in an amount included in the assessable income of a beneficiary in respect of a share of the net income of a trust, or an increase in an amount assessable to a trustee in respect of a beneficiary's share of the net income of a trust. However, in circumstances where a partner in an Australian partnership, a beneficiary of an Australian trust or the trustee of an Australian trust, is treated as having suffered a reduction to a tax detriment for the purposes of section 460 of the ITAA 1936, the reduction to the relevant taxpayer's DPT tax benefit should not include the amount of that tax detriment reduction.

The scheme must be entered into for a principal purpose of obtaining a tax benefit

1.37 The primary condition for the DPT to apply to a scheme is that it would be concluded, having regard to the matters in subsection 177J(2), that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a principal purpose of, or for more than one principal purpose that includes a purpose of:

•

enabling the relevant taxpayer to obtain one or more tax benefits, or both to obtain one or more tax benefits and to reduce one or more foreign tax liabilities, in connection with the scheme; or

•

enabling the relevant taxpayer and another taxpayer each to obtain one or more tax benefits, or both to obtain one or more tax benefits and to reduce one or more foreign tax liabilities, in connection with the scheme.

[Schedule 1, item 13, paragraph 177J(1)(b) of the ITAA 1936]

1.38 For these purposes, the deferral of a taxpayer's liabilities to tax under a foreign law (as defined in section 177A of the ITAA 1936) is taken to be a reduction of those liabilities, unless there are reasonable commercial grounds for the deferral. This is intended to ensure that longer term deferrals of taxes under a foreign law may give rise to a foreign tax benefit, but is not intended to capture short term deferrals.

[Schedule 1, item 13, subsection 177J(3) of the ITAA 1936]

1.39 The Commissioner's ability to make a conclusion is not prevented by a lack of, or incomplete, information provided by the taxpayer. In addition, the Commissioner is not required to actively seek further information to reach a conclusion.

1.40 The requirements in subparagraph 177J(1)(b)(ii) of the ITAA 1936 will be satisfied where:

•

the relevant taxpayer obtains a tax benefit; and

•

another taxpayer obtains a reduction in a foreign tax liability.

1.41 In considering paragraph 177J(1)(b) of the ITAA 1936, the purposes of obtaining a tax benefit and of reducing a foreign tax liability can be combined and considered together to determine whether the combined purpose was a principal purpose of a person, or more than one person, who entered into or carried out the scheme, or any part of the scheme.

1.42 The person who entered into or carried out the scheme or any part of the scheme does not have to be the same person as the taxpayer who obtains the tax benefit, or both obtains the tax benefit and reduces a foreign tax liability in connection with the scheme.

[Schedule 1, item 5, paragraph 177J(1)(b) of the ITAA 1936]

1.43 This is important because significant global entities that seek to obtain a tax benefit in Australia may also arrange their affairs so as to pay less tax in other jurisdictions. The DPT is designed to apply notwithstanding that the entities that enter into or carry out the scheme or any part of the scheme have an additional purpose of reducing tax liabilities of the group under foreign laws.

1.44 The required purpose must be established objectively based on the information available to the Commissioner at the time that he or she decides to make a DPT assessment and an analysis of how the scheme was implemented, what the scheme actually achieved as a matter of substance or reality as distinct from legal form (that is, its end effect), and the nature of any connection between the taxpayer and other parties.

1.45 Consistent with the current purpose test for the general anti-avoidance rule in subsection 177D(2) of the ITAA 1936 and for the multinational anti-avoidance law in subsection 177DA(1), it is the purpose of the person or one or the persons who entered into or carried out the scheme or any part of the scheme that is assessed under the DPT. Where a person acts on professional advice, it may be appropriate, in certain circumstances, to attribute the objective purpose of the professional adviser to the person.

1.46 The 'principal purpose or more than one principal purpose' threshold is lower than the 'sole or dominant purpose threshold', which is used in subsection 177D(1) of the ITAA 1936. Consistent with the multinational anti-avoidance law, the relevant principal purpose need not be the sole or dominant purpose of a person or persons who entered into or carried out the scheme, but must be one of the main purposes, having regard to all the facts and circumstances.

1.47 This recognises that a scheme or part of a scheme may be entered into or carried out for a number of purposes, some or all of which are principal purposes. The scheme will be caught under section 177J of the ITAA 1936 as long as one of those principal purposes satisfies the tax benefit requirements of the principal purpose test.

1.48 The 'principal purpose or more than one principal purpose' test is used in the multinational anti-avoidance law and reflects the language used in the 2015 OECD Report titled 'Preventing the Granting of Treaty Benefits in Inappropriate Circumstances'. The report aims to reduce or address treaty abuse through an anti-abuse rule based on 'one of the principle purposes of any arrangements or transactions'.

1.49 After the multinational anti-avoidance law was introduced, the Commissioner released Law Companion Guideline LCG 2015/2. In discussing the principal purpose test, the Law Companion Guideline (at paragraphs 12 to 15) states that:

'Principal' is not defined in the Bill. The Macquarie Dictionary defines principal as '1. first or highest in rank, importance, value, etc.; chief; foremost.'. The Oxford English Dictionary defines 'principal' as '1. Of a number of things or persons, or one of their number: belonging to the first rank; among the most important; prominent, leading, main'. This can be compared to 'dominant' which is defined as 'ruling; governing; controlling; most influential...main; major; chief' (Macquarie Dictionary) and 'ruling, governing, commanding; most influential' (Oxford English Dictionary).

In using the language 'or for more than one principal purpose' it is clear that Parliament intended there to be more than one possible principal purpose for entering into the scheme. Therefore, in this context, 'principal' does not mean strictly 'first or highest in rank', but rather 'among the most important, prominent, leading, main'.

One critical difference between the principal purpose test in paragraph 177DA(1)(b) and the sole or dominant test in existing subsection 177D(1) is that the test in 177DA(1)(b) is not whether 'the' principal purpose was to obtain a tax benefit (or to also reduce a liability to foreign tax). Rather, the test allows for a number of principal purposes and looks to whether one of those principal purposes was to obtain a tax benefit (or to also reduce a liability to foreign tax). Accordingly, it does not have to be the main purpose, just one of the main purposes for entering into the scheme. This means that where a person who entered into or carried out a scheme has a main purpose of obtaining a tax benefit and also has a main purpose of achieving a particular commercial objective, the principal purpose test will still be met in relation to that scheme, without the need to determine which of the main purposes is the dominant purpose.

The intention, as explained in the Explanatory Memorandum (EM) to the Bill, is for this test to be consistent with the approach to be taken internationally through the OECD Base Erosion and Profit Shifting (BEPS) work on Action 6 (Preventing the granting of treaty benefits in inappropriate circumstances). The OECD Report on Action 6, published on 5 October 2015, recommends new OECD Model provisions, one of which involves a principal purpose test that adopts the words '...one of the principal purposes ...'. Given the similarity in wording and the statements in the EM to the Bill, the ATO considers the proposed Commentary to the OECD Model on the principal purpose test is relevant guidance on the meaning of '... a principal purpose of, or for more than one principal purpose that includes a purpose of...' in section 177DA.

1.50 In coming to a conclusion about whether the purpose test is satisfied, regard must be had to:

•

the matters listed in subsection 177D(2) of the ITAA 1936;

•

the extent to which non-tax financial benefits that are quantifiable have resulted, will result, or may reasonably be expected to result, from the scheme;

•

the result, in relation to the operation of any foreign law relating to taxation, that would be achieved by the scheme; and

•

the amount of the tax benefit that arises in connection with the scheme.

[Schedule 1, item 13, subsection 177J(2) of the ITAA 1936]

1.51 Consistent with the consideration of the factors in subsection 177D(2) of the ITAA 1936 that are relevant to determination of purpose under the general anti-avoidance rule (section 177D) and the multinational anti-avoidance law (section 177DA), the enquiry relates to objective (rather than subjective) purpose and each of the additional factors must be considered and accorded appropriate weight. Case law relating to the application of the factors in subsection 177D(2) will be relevant to the application of subsection 177J(2), along with the additional specific factors.

1.52 The significance of quantifiable non-tax financial benefits which have, may or will result, or may reasonably be expected to result, from the scheme, relates to the amount of those benefits relative to the tax benefit. If the scheme produces significant quantifiable non-tax financial benefits, this could be a strong indicator that the purpose of the scheme was not to produce the tax benefit. This factor is weighed alongside the other factors in subsection 177J(2) in determining if the overall facts and circumstances of the scheme point to an objective purpose of enabling a taxpayer to obtain a tax benefit.

1.53 Non-tax financial benefits are quantifiable commercial benefits arising from a scheme for example, a computable and identifiable amount of economic value generated from the scheme. Tax outcomes are not included in this quantification. The quantification of non-tax financial benefits is based on the value of those benefits at the time of entering into the scheme.

1.54 Consideration of non-tax financial benefits identified in subsection 177J(2)(b) should generally be based on the anticipated outcomes at the time of entry into the scheme. Provided the anticipated outcomes were based on reasonable commercial assumptions, the fact that the anticipated outcomes do not eventuate does not in itself indicate a principal purpose of obtaining a tax benefit. However, the anticipated outcomes may carry less weight where the scheme has been implemented in a different manner to that which was anticipated at the outset of the scheme.

1.55 A taxpayer may provide evidence to support the non-tax financial benefits of the scheme, including but not limited to:

•

representations made to management and Boards of the entities involved in a restructure; and

•

evidence of the non-tax financial benefits that have actually accrued to date and that are anticipated to accrue in the future.

1.56 Examples of non-tax financial benefits (to the extent to which they are quantifiable) that may be considered include, but are not limited to:

•

any productivity gains and/or cost savings in connection with the scheme;

•

the value added, or synergies resulting from any assets used, functions performed or risks assumed in connection with the scheme;

•

where the scheme involves the transfer of assets used, functions performed or risks assumed in connection with the scheme, the extent to which those assets, functions and risks replace or merely replicate the existing assets, functions and risks in the global value chain;

•

any location specific benefits

-

for example, reduced distribution costs from proximity to the customer base or improved access to staff with the relevant skill set required to undertake economically significant functions;

•

any reduction of non-income tax costs resulting from the scheme (for example, tariffs, payroll taxes and stamp duties); and

•

any provision of non-tax Government incentives in connection with the scheme;

1.57 There may be other commercial benefits that arise from the scheme that are not quantifiable, which may be relevant considerations for other factors in subsection 177D(2).

1.58 Consistent with the multinational anti-avoidance law, one of the additional matters that is considered in determining purpose is the result, in relation to the operation of any foreign law, relating to taxation, that would be achieved by the scheme. The focus of this additional matter is on the result that is achieved under foreign laws relating to tax for each taxpayer that is connected with the scheme. This is relevant for determining whether a person had a purpose of enabling a taxpayer (or taxpayers) to reduce their foreign tax liability in connection with the scheme.

1.59 Facts and circumstances surrounding the use of foreign tax losses, foreign tax credits or other foreign tax attributes may be taken into account in determining whether the relevant taxpayer has a principal purpose of obtaining a tax benefit, or both a tax benefit and a foreign tax benefit. This will often be a question of fact and degree, and in assessing the factors in subsection 177J(2), one consideration will be whether the utilisation of those tax attributes formed part of the scheme.

1.60 For example, the utilisation of commercial foreign loss that arose after the scheme is entered into by a foreign associate in a high tax jurisdiction, may indicate that the relevant taxpayer did not have a principal purpose of obtaining a tax benefit, or both a tax benefit and a foreign tax benefit (provided there are no other facts suggesting the scheme or any part of the scheme was designed to use those losses).

Example 1.3

Aus Co is a part of a multinational group where each subsidiary of the group around the world has its own technical services support centre. A restructure is undertaken to centralise the technical support functions into regional zones, including one in the Asia Pacific region.

After consideration of various options, the group decides to locate the Asia Pacific technical support centre in a subsidiary resident in a location with a 20 per cent corporate tax rate. There were other potential locations in higher tax jurisdictions in the region which may also have been suitable locations.

Aus Co closes down its own technical support centre and relocates a number of staff to the Asia Pacific service centre. The Asia Pacific service centre also employs a number of technical support specialists. Aus Co begins to pay the Asia Pacific technical support centre a service fee.

The Commissioner identifies a possible scheme to relocate the technical services to a lower tax jurisdiction and a tax benefit arising from the deduction for the service fee.

However, Aus Co is able to demonstrate that there are significant quantifiable non-tax financial benefits arising from the scheme relative to the tax benefits, by providing financial projections prepared at the time of the restructure showing the expected productivity and efficiency gains from centralising the technical support functions and lower wage costs in the chosen location.

The Commissioner assesses the evidence provided in combination with the other factors listed in section 177J(2) and determines that these factors point to the conclusion that the scheme was not entered into for a principal purpose of obtaining a tax benefit.

Example 1.4

Australian Insurance Co enters into a reinsurance contract with a Foreign Reinsurance Co.

Generally, if an Australian insurance company enters into a reinsurance contract with a foreign resident insurer, then subsection 148(1) of the ITAA 1936 applies so that:

•

insurance premiums paid or credited in respect of the foreign reinsurance are not deductible to the Australian insurer;

•

these insurance premiums are not assessable income of the foreign reinsurer; and

•

the assessable income of the Australian insurer does not include the amount of any reinsurance recoveries from the foreign reinsurer in respect of a loss on any reinsured risk.

The effect is that the profit or loss made by the foreign reinsurer is merged with the financial position of the Australian insurer that pays the reinsurance premiums.

•

If a profit is made by the foreign reinsurer, the Australian insurer effectively bears the tax on that profit.

•

If a loss is made by the foreign reinsurer, the Australian insurer obtains a tax deduction for the amount of the loss.

However, an Australian insurance company enters into a reinsurance contract with a foreign resident insurer can make an election under subsection 148(2) not to apply subsection 148(1). If an election is made:

•

insurance premiums paid or credited in respect of the foreign reinsurance are deductible to the Australian insurer; and

•

the assessable income of the Australian insurer does include the amount of any reinsurance recoveries from the foreign reinsurer in respect of a loss on any reinsured risk; and

•

the Australian insurer is liable to lodge tax returns and to pay tax as agent for the foreign reinsurer.

If Australian Insurance Co makes an election under subsection 148(2), then Australian Insurance Co:

•

can deduct the reinsurance premiums for income tax purposes; and

•

will be taxed, as agent of Foreign Reinsurance Co, on 10 per cent of the gross amount of the reinsurance premiums.

In these circumstances, by itself, the making of the election will not be considered to give rise to a conclusion that the company has entered into a scheme for the principal purpose of obtaining a tax benefit simply due to the fact that there is a reduction in tax payable - as the making of the election is fully compliant with the ordinary operation of the income tax law.

However, in considering the application of the DPT, it would be necessary to consider all aspects of the scheme beyond the making of the election itself in determining whether there was a principal purpose to obtain a tax benefit or whether the sufficient economic substance test has been satisfied.

The relevant taxpayer must be a significant global entity

1.61 For the DPT to apply, the relevant taxpayer must be a significant global entity for the income year.

[Schedule 1, item 13, paragraph 177J(1)(c) of the ITAA 1936]

1.62 An entity is a significant global entity for an income year if it has annual global income of $1 billion or more in that income year (subsection 960-555(1) of the ITAA 1997).

1.63 An entity will also be a significant global entity if it is a meMber of a group of entities that are consolidated for accounting purposes as a single group, and one of the other members of the group is a global parent entity whose annual global income is $1 billion or more (subsection 960-555(2) of the ITAA 1997).

A foreign entity must be an associate and involved in the scheme

1.64 For the DPT to apply, a foreign entity must be an associate (within the meaning of section 318 of the ITAA 1936) of the relevant taxpayer in the relevant income year.

[Schedule 1, item 13, paragraph 177J(1)(d) of the ITAA 1936]

1.65 In addition, that foreign entity must be:

•

the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme; or

•

otherwise connected to the scheme or any part of the scheme.

[Schedule 1, item 13, paragraph 177J(1)(e) of the ITAA 1936]

1.66 Therefore, the DPT will apply if at least one of the parties to the scheme is a foreign entity. An entity is a foreign entity if it is not an Australian entity (see the definition of foreign entity in subsection 177A(1) of the ITAA 1936). An Australian entity is defined in subsection 177A(1) to have the same meaning as in Part X of that Act (see section 336).

1.67 Consequently, if the only entities that are connected to a scheme are Australian entities, the DPT will not apply to the scheme.

Certain entities excluded from being relevant taxpayers under DPT

1.68 Certain types of entities have been excluded from being a relevant taxpayer for the purposes of the DPT. These entities are considered low risk from an integrity perspective, being sovereign owned or widely held entities that carry on predominately passive activities. The exclusion ensures that these entities do not face an unnecessary compliance burden as a result of the introduction of the DPT.

1.69 The exclusion applies to an entity that is:

•

a managed investment trust;

•

a foreign collective investment vehicle with wide membership;

•

an entity owned by a foreign government, where that entity is a foreign entity;

•

a complying superannuation entity; or

•

a foreign pension fund.

[Schedule 1, item 13, paragraph 177J(1)(f) of the ITAA 1936]

1.70 The exclusion from the DPT for these types of entities does not exempt significant global entities who are associates of those entities from being relevant taxpayers for the purposes of the DPT.

1.71 A managed investment trust is defined in section 275-10 of the ITAA 1997 to mean, broadly, an Australian trust that meets certain widely-held ownership tests and does not carry on or control a trading business.

1.72 An entity is a foreign collective investment vehicle with wide membership entity if it is covered by paragraph 275-20(4)(f) of the ITAA 1997 - that is, it is an entity:

•

that is recognised under a foreign law as being used for collective investment by pooling the contributions of its members as consideration to acquire rights to benefits produced by the entity;

•

that has at least 50 members; and

•

the contributing members of which do not have day-to-day control over the entity's operation.

1.73 An entity is an entity owned by a foreign government if it is covered by paragraph 275-20(4)(h) of the ITAA 1997 - that is, it is an investment entity that satisfies all of the following requirements:

•

the entity is wholly owned by one or more foreign government agencies, or is a wholly-owned subsidiary of one or more foreign government agencies;

•

the entity is established using only the public money or public property of the foreign government concerned; and

•

all economic benefits obtained by the entity have passed, or are expected to pass, to the foreign government concerned.

1.74 However, an investment entity owned by a foreign government that satisfies these conditions will be excluded from being a relevant taxpayer for the purposes of the DPT only if it is a foreign entity (as defined in section 177A of the ITAA 1936).

1.75 An entity is a complying superannuation entity (as defined in the ITAA 1997) if it is:

•

a complying superannuation fund;

•

a complying approved deposit fund; or

•

a pooled superannuation trust.

1.76 A foreign pension fund is defined in subsection 840-805(4B) of the ITAA 1997 to mean:

•

an entity, the principal purpose of which is to fund foreign pensions (including disability and similar benefits) for the citizens or other contributors of a foreign country, that is established by an exempt foreign government agency or under a foreign law for an exempt foreign government agency; or

•

a foreign superannuation fund (as defined in subsection 995-1(1) of the ITAA 1997) that has at least 50 members.

Additional tests to determine whether the DPT will apply

1.77 The DPT will apply in relation to the relevant taxpayer, in relation to a DPT tax benefit, only if it is reasonable to conclude that none of the following tests applies:

•

the $25 million income test;

•

the sufficient foreign tax test; or

•

the sufficient economic substance test.

[Schedule 1, item 13, paragraph 177J(1)(g), sections 177K, 177L and 177M of the ITAA 1936]

1.78 These tests ensure that the DPT is appropriately targeted and does not impose an undue compliance burden on low risk taxpayers. However, a taxpayer must provide sufficient information to satisfy the Commissioner that any one of these tests may apply to it. In this regard, the reasonable conclusion will be made based on the information available to the Commissioner at the time the tests are being considered.

The $25 million income test

1.79 Under the $25 million income test, the DPT will not apply in relation to the relevant taxpayer, in relation to a DPT tax benefit, if it is reasonable to conclude that, for the income year, the sum of following amounts does not exceed $25 million:

•

the assessable income, exempt income and non-assessable non-exempt income of the relevant taxpayer;

•

the assessable income of another entity that is an associate (as defined in section 318 of the ITAA 1936) of the relevant taxpayer, where both the relevant taxpayer and the other entity are significant global entities because they are members of the same global group; and

•

if the DPT tax benefit is a tax benefit of a type mentioned in paragraph 177C(1)(a) (that is, a tax benefit that relates to an amount not being included in assessable income), the amount of the DPT tax benefit.

[Schedule 1, item 13, paragraphs 177J(1)(g) and section 177K of the ITAA 1936]

1.80 The $25 million income test ensures that the DPT does not apply in circumstances where the operations of the relevant taxpayer and associated Australian entities are relatively small.

The sufficient foreign tax test

1.81 Under the sufficient foreign tax test, the DPT will not apply in relation to the relevant taxpayer, in relation to a DPT tax benefit, if it is reasonable to conclude that, in relation to the scheme, the increase in the liability for foreign income tax (as defined in the ITAA 1997) is equal to or exceeds 80 per cent of the corresponding reduction in the Australian tax liability.

[Schedule 1, item 13, paragraph 177J(1)(g) and subsection 177L(1) of the ITAA 1936]

1.82 The term foreign income tax is defined in section 770-15 of the ITAA 1997 to mean tax imposed by a law other than an Australian law that is:

•

tax on income;

•

tax on profits or gains, whether of an income or capital nature; or

•

any other tax, being a tax that is subject to a double tax agreement.

1.83 However, foreign income tax does not include:

•

a credit absorption tax as defined in subsection 770-15(2) of the ITAA 1997; or

•

a unitary tax as defined in subsection 770-15(3) of the ITAA 1997.

1.84 Therefore, in calculating the increase in the foreign tax liability and the corresponding reduction in the Australian tax liability, goods and services tax (and any foreign equivalents) is not included.

1.85 For the sufficient foreign tax test to apply, the relevant taxpayer will need to provide information to the Commissioner relating to the amount of the increased foreign tax liability in relation to the scheme. That information will need to be sufficient to support a reasonable conclusion that a sufficient amount of foreign tax has been, will be, or may reasonably expected to be, paid in relation to a foreign tax period that corresponds to the relevant income year.

1.86 For certain types of entities that are treated as fiscally transparent for tax purposes in another jurisdiction, the relevant taxpayer may be able to satisfy the test by providing information to the Commissioner to demonstrate that a sufficient level of foreign tax was ultimately paid by the holders of membership interests in the transparent entity. Similarly, if the income is ultimately subject to tax in the hands of another entity, the relevant taxpayer may be able to provide evidence to the Commissioner that those entities should be included in the scheme and the foreign tax paid taken into account in the sufficient foreign tax test.

1.87 For the purposes of the sufficient foreign tax test, the increased foreign tax liability is the total amount of any increases in foreign tax liability of certain foreign entities that results, will result, or may be reasonably expected to result, from the scheme during a foreign tax period that corresponds to the relevant income year.

[Schedule 1, item 13, subsection 177L(2) of the ITAA 1936]

1.88 The amount of the increased foreign tax liability is worked out based on the amount of foreign taxes that are, or are equivalent to, income taxes actually paid in relation to the scheme. Therefore, to work out the amount of the increased foreign tax liability, it is necessary to consider any specific tax relief provided by a foreign country in relation to the scheme.

1.89 Consequently, the amount of the increased foreign tax liability in relation to the scheme cannot always be worked out simply by looking at the headline corporate tax rate in the foreign country in which tax is paid. Rather, the amount of the increased foreign tax liability is the increased amount of foreign tax actually paid, or that can reasonably be expected to be paid, as a result of the scheme.

1.90 In addition, it may be the case that a reduced or nil amount of foreign tax is paid during all or some of the years to which the scheme relates, notwithstanding the foreign associate is resident in a jurisdiction with a high headline tax rate, due to the application of a foreign tax loss, foreign tax credit or other foreign tax attributes.

1.91 In these circumstances, in calculating the increase in the liability for foreign income tax, it is the actual foreign tax liability (after a reduction for foreign tax losses, foreign tax credits or other foreign tax attributes) which is the relevant measure. However, the facts and circumstances surrounding the use of those foreign tax losses, foreign tax credits or other foreign tax attributes may be taken into account in determining whether the relevant taxpayer has a principal purpose of obtaining a tax benefit, or both a tax benefit and a foreign tax benefit.

1.92 The increased foreign tax liability of an entity will be taken into account for these purposes if the entity is:

•

a foreign entity;

•

the relevant taxpayer or an associate (as defined in section 318 of the ITAA 1936) of the relevant taxpayer; and

•

the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme, or is otherwise connected to the scheme or any part of the scheme.

[Schedule 1, item 13, subsection 177L(5) of the ITAA 1936]

1.93 An entity is a foreign entity if it is not an Australian entity (see the definition of foreign entity in subsection 177A(1) of the ITAA 1936). An Australian entity is defined in subsection 177A(1) to have the same meaning as in Part X of that Act (see section 336 of the ITAA 1936).

1.94 The income tax regulations may provide for a method in working out the amount of the foreign tax liability for the purposes of the sufficient foreign tax test:

•

for all situations; or

•

for specified situations.

[Schedule 1, item 13, subsection 177L(3) of the ITAA 1936]

1.95 If the regulations provide for such a method, that method must be applied for the purposes of working out increases in the foreign tax liability for the purposes of subsection 177L(2) in relevant situations.

[Schedule 1, item 13, subsection 177L(4) of the ITAA 1936]

1.96 The calculation of the amount of increases in the foreign tax liability may be complex and uncertain. Therefore, if practical difficulties arise in applying subsection 177L(2), the regulations will be able to clarify the approach for working out increases in the foreign tax liability in particular circumstances.

1.97 The Australian tax liability is:

•

if the tax benefit relates to the amount of assessable income, the amount of an allowable deduction, the amount of a capital loss - the amount of the tax benefit multiplied by the standard Australian corporate tax rate; or

•

if the tax benefit relates to the amount of a foreign income tax offset, an innovation tax offset, an exploration credit or an amount that is subject to withholding tax

-

the amount of the tax benefit.

[Schedule 1, item 13, subsection 177L(6) of the ITAA 1936]

1.98 However, if the relevant taxpayer must withhold an amount in respect of withholding tax as a result of the tax benefit, the amount of the Australian tax liability is reduced by the amount withheld.

[Schedule 1, item 13, subsection 177L(7) of the ITAA 1936]

1.99 Withholding tax is defined in subsection 6(1) of the ITAA 1936 to have the same meaning as in the ITAA 1997. The term is defined in subsection 995-1(1) of the ITAA 1997 to mean income tax payable under withholding tax liability provisions in the Australian income tax law.

Example 1.5

Where a tax benefit is a deductible payment (that is, a tax benefit that arises under paragraph 177C(1)(b) of the ITAA 1936) of $1 million, the amount of the reduced Australian tax liability worked out under paragraph 177L(4)(a) is $300,000 - that is, the amount of the tax benefit multiplied by 30 per cent.

If the deductible payment is subject to Australian withholding tax and the relevant taxpayer is required to withhold an amount in respect of withholding tax, the Australian tax liability is reduced by the amount withheld.

If the deductible payment is an amount of interest to a foreign resident, the amount of the liability to withholding tax the taxpayer would have been expected to pay is $100,000 - that is, 10 per cent of $1 million.

Therefore, the amount of the reduced Australian tax liability will be $200,000.

Example 1.6

Australia Co and Foreign Co are associates. The Commissioner has identified a scheme to divert profits from Australia that involves a payment of $100 million from Australia Co to Foreign Co.

The Commissioner has access to information that the corporate tax rate in the foreign jurisdiction is 17 per cent, enabling the Commissioner to estimate that the foreign tax liability is approximately $17 million (17 per cent of the $100 million payment).

On the basis of this available information, the Commissioner does not consider that it is reasonable to conclude that, as a result of the scheme, the increase in the foreign tax liability of Foreign Co equals or exceeds 80 per cent of the corresponding reduction in the Australian tax liability. This is because $17 million is less than 80 per cent of the $100 million payment multiplied by the Australian corporate tax rate (that is, ($100 million x 80 per cent) x 30 per cent = $24 million).

Therefore, Australia Co, as the relevant taxpayer, does not pass the sufficient foreign tax test on the basis of the information currently available to the Commissioner.

To meet the sufficient foreign tax test, Australia Co will need to provide further information to the Commissioner to show that Foreign Co has a higher foreign tax liability.

Example 1.7

Australia Co, Foreign Co A and Foreign Co B are associates.

The Commissioner has identified a scheme to divert profits from Australia that involves back to back payments between the three entities.

The Commissioner already has access to information that the corporate tax rates in Foreign Co A's jurisdiction is 30 per cent and Foreign Co B's jurisdiction is 17 per cent.

As part of the scheme, the Commissioner has access to information that:

•

a payment of $100 million was made from Australia Co to Foreign Co A; and

•

Foreign Co A made a related payment to Foreign Co B as part of the scheme.

The Commissioner does not possess information regarding the exact amount of this further payment made in relation to the scheme, but based on the information available, considers that it may be significant enough to result in the foreign tax liability being reduced below the necessary threshold, particularly as it would lead to a smaller foreign tax liability in Foreign Co A's jurisdiction.

On the basis of this available information, the Commissioner does not consider that it is reasonable to conclude that as a result of the scheme, the total increase in the foreign tax liability of Foreign Co A and Foreign Co B equals or exceeds 80 per cent of the corresponding reduction in the Australian tax liability. Therefore, Australia Co, as the relevant taxpayer, does not pass the sufficient foreign tax test on the basis of the information currently available to the Commissioner.

To meet the sufficient foreign tax test, Australia Co will need to provide further information to the Commissioner to show that in total, Foreign Co A, Foreign Co B and/or other associated entities have a sufficient foreign tax liability as a result of the scheme.

The sufficient economic substance test

1.100 Under the sufficient economic substance test, the DPT will not apply in relation to the relevant taxpayer, in relation to a DPT tax benefit, if it is reasonable to conclude that the profit made as a result of the scheme by each entity covered by subsection 177M(2) reasonably reflects the economic substance of the entity's activities in connection with the scheme.

[Schedule 1, item 13, paragraph 177J(1)(g) and subsection 177M(1) of the ITAA 1936]

1.101 This ensures that the DPT will not apply where there is a commercial transfer of economic activity and functions to another jurisdiction, notwithstanding that jurisdiction has a lower tax rate.

1.102 An entity is covered by subsection 177M(2) if the entity is the relevant taxpayer, or the entity is both:

•

an associate (within the meaning of section 318 of the ITAA 1997) of the relevant taxpayer; and

•

entered into or carried out the scheme or any part of the scheme, or is otherwise connected with the scheme or any part of the scheme.

[Schedule 1, item 13, subsection 177M(2) of the ITAA 1936]

1.103 However, if the entity's role in the scheme is minor or ancillary, the entity is disregarded for these purposes.

[Schedule 1, item 13, subsection 177M(3) of the ITAA 1936]

1.104 The judgement about whether an entity's role in the scheme is minor or ancillary will be a question of fact and degree in each case. Generally, an entity will be considered to have a minor or ancillary role if both of the following are satisfied:

•

the entity has no material bearing on the effectiveness or operation of the scheme; and

•

the entity receives minimal income from the scheme.

1.105 However, the role of the entity will not be considered minor or ancillary, where:

•

an integral part of the scheme involves the fragmentation of functions to different associated entities, with the result that each of those entities are carrying out only a minor part of the scheme; and

•

when considered together, the scheme gives rise to combined profits that are not commensurate with the collective activities undertaken.

1.106 For the purpose of determining whether the profit made as a result of the scheme by an entity reasonably reflects the economic substance of the entity's activities in connection with the scheme, regard should be had to:

•

the functions that the entity performs in connection with the scheme, taking into account the assets used and risks assumed by the entity in connection with the scheme;

•

the documents covered by section 815-135 of the ITAA 1997, to the extent that they are relevant to these matters or to any other aspect of the determination; and

•

any other relevant matters.

[Schedule 1, item 13, subsection 177M(4) of the ITAA 1936]

1.107 The documents covered by section 815-135 of the ITAA 1997 are the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations as approved by the Council of the OECD and last amended on 23 May 2016 (see Schedule 3 to this Bill).

1.108 Regard should be had to the documents covered by section 815-135 of the ITAA 1997 when considering matters such as:

•

the functions performed, assets used and risks assumed by the entity in connection with the scheme to the extent they are relevant; and

•

any other aspect of making the determination, such as the consideration of whether the profits made by the entity reasonably reflect the economic substance of the entity's activities.

1.109 These documents provide guidance on how a functional analysis is performed for the purposes of delineating a transaction and also outlines a number of other economically relevant characteristics to ensure the functional analysis reflects an accurate delineation of the transaction.

1.110 While the sufficient economic substance test should be assessed with regard to these matters, this does not prevent the Commissioner or the taxpayer taking into account any other matters that may be relevant in determining whether the profit made as a result of the scheme reasonably reflects the economic substance of an entity's activities in connection with the scheme from being taken into account. To the extent that they are relevant, regard should be had to the OECD Transfer Pricing Guidelines in considering any additional matters.

Applying the sufficient economic substance test

1.111 The sufficient economic substance test requires an analysis of the economic substance of the activities of the relevant taxpayer and any other Australian or non-resident associate entity connected with the scheme. In applying the test, it is the economic substance of the entity's activities in connection with the scheme that are relevant, not the overall economic substance of the entity itself. For example, an entity may have significant operations and employees, but the actual activities and functions undertaken by those employees in connection with the scheme may be small relative to the profits made by that entity in connection with that scheme.

1.112 In addition, the entity's role and activities within the overall scheme are relevant in determining the economic substance of that entity's activities. For example, self-cancelling, offsetting or circular transactions, and 'back to back' arrangements where the entity does not deliver on its contractual obligations directly but reassigns this role to another entity indicate another entity is in fact carrying out the economically significant functions and assuming the associated risks.

1.113 Once the economically significant functions and entities carrying out those functions in the scheme have been identified, the focus is on the relativity of the profits made compared to the activities undertaken. For example, if a foreign associate enters into a contract with the relevant taxpayer to provide services, then subcontracts out its obligations to another related entity, it would have to demonstrate that the margin retained is commensurate with the activities (or lack of activities) undertaken.

The OECD Transfer Pricing Guidelines

1.114 The OECD Report, Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10-2015 Final Reports, published by the OECD on 5 October 2015 (the 2015 Recommendations), updates the OECD Transfer Pricing Guidelines.

1.115 Paragraphs 1.34 and 1.35 of the 2015 Recommendations provide that identifying the relevant commercial or financial relations requires a broad-based understanding of the industry sector in which the multinational group operates. This analysis is then narrowed to identify how each entity within the multinational group operates and their commercial or financial relations as expressed in transactions between them.

1.116 The accurate delineation of the actual transaction or transactions between the associated enterprises requires analysis of the economically relevant characteristics of the transaction. These economically relevant characteristics consist of the conditions of the transaction and the economically relevant circumstances in which the transaction takes place.

1.117 The application of the arm's length principle depends on determining the conditions that independent parties would have agreed in comparable transactions in comparable circumstances. Before making comparisons with uncontrolled transactions, it is therefore vital to identify the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction.

1.118 In completing this analysis, paragraph 1.36 of the 2015 Recommendations provides that the economically relevant characteristics or comparability factors that need to be identified in order to accurately delineate the actual transaction can be broadly categorised as follows:

•

the contractual terms of the transaction (see Chapter 1, D.1.1 of the 2015 Recommendations);

•

the functions performed by each of the parties to the transaction, taking into account assets used and risks assumed, including how those functions relate to the wider generation of value by the multinational group to which the parties belong, the circumstances surrounding the transaction, and industry practices (see Chapter 1, D.1.2 of the 2015 Recommendations);

•

the characteristics of property transferred or services provided (see Chapter 1, D.1.3 of the 2015 Recommendations);

•

the economic circumstances of the parties and of the market in which the parties operate (see Chapter 1, D.1.4 of the 2015 Recommendations); and

•

the business strategies pursued by the parties (see Chapter 1, D.1.5 of the 2015 Recommendations).

1.119 Paragraph 1.35 of the 2015 Recommendations specifies that identifying the economically relevant characteristics of the commercial or financial relations as expressed in the controlled transaction is a vital step in any transfer pricing analysis which must be undertaken prior to making comparisons to uncontrolled transactions or applying the arm's length principle.

1.120 Therefore, a key step in demonstrating economic substance will be to complete a functional analysis that examines the functions that the entity performs in connection with the scheme, taking into account assets used and risks assumed by the entity in connection with the scheme.

1.121 In determining the economic substance of an entity's activities, it may be necessary to disregard contractually assigned functions or transactions where the characteristics of the transaction that are economically relevant are inconsistent with the written contract between the associated enterprises. Chapter D1.1 of the 2015 Recommendations provides a more detailed explanation of the role of contractual terms and the delineation of those contractual terms and the actual transactions or activities taking place.

1.122 These concepts are illustrated by the following examples from the 2015 Recommendations:

Example 1.8

This example is in Paragraph 1.44 of the 2015 Recommendations.

Company P is the parent company of an MNE group situated in Country P. Company S, situated in Country S, is a wholly-owned subsidiary of Company P and acts as an agent for Company P's branded products in the Country S market.

The agency contract between Company P and Company S is silent about any marketing and advertising activities in Country S that the parties should perform. Analysis of other economically relevant characteristics and in particular the functions performed, determines that Company S launched an intensive media campaign in Country S in order to develop brand awareness. This campaign represents a significant investment for Company S.

Based on evidence provided by the conduct of the parties, it could be concluded that the written contract may not reflect the full extent of the commercial or financial relations between the parties. Accordingly, the analysis should not be limited by the terms recorded in the written contract, but further evidence should be sought as to the conduct of the parties, including as to the basis upon which Company S undertook the media campaign.

Example 1.9

This example is in Paragraph 1.48 of the 2015 Recommendations.

Company S is a wholly-owned subsidiary of Company P. The parties have entered into a written contract pursuant to which Company P licenses intellectual property to Company S for use in Company S's business; Company S agrees to compensate Company P for the licence with a royalty.

Evidence provided by other economically relevant characteristics, and in particular the functions performed, establishes that Company P performs negotiations with third-party customers to achieve sales for Company S, provides regular technical services support to Company S so that Company S can deliver contracted sales to its customers, and regularly provides staff to enable Company S to fulfil customer contracts. A majority of customers insist on including Company P as joint contracting party along with Company S, although fee income under the contract is payable to Company S.

The analysis of the commercial or financial relations indicates that Company S is not capable of providing the contracted services to customers without significant support from Company P, and is not developing its own capability. Under the contract, Company P has given a licence to Company S, but in fact controls the business risk and output of Company S such that it has not transferred risk and function consistent with a licensing arrangement, and acts not as the licensor but the principal.

The identification of the actual transaction between Company P and Company S should not be defined solely by the terms of the written contract. Instead, the actual transaction should be determined from the conduct of the parties, leading to the conclusion that the actual functions performed, assets used, and risks assumed by the parties are not consistent with the written licence agreement.

1.123 The functional analysis in Chapter 1, D1.2 of the 2015 Recommendations seeks to identify the economically significant activities and responsibilities undertaken, assets used or contributed, and risks assumed by the parties to the transactions (see paragraph 1.51 of the 2015 Recommendations).

1.124 This will focus on what the parties actually do and the capabilities they provide, decision making processes, types of assets used and the capabilities of the parties and how those capabilities are reflected in potentially comparable arm's length arrangements (see paragraphs 1.51, 1.53 and 1.54 of the 2015 Recommendations).

1.125 In undertaking this analysis, the 2015 Recommendations outline the following factors:

•

decision-making, including decisions about business strategy and risks - as outlined in paragraph 1.51 of the 2015 Recommendations, this will involve a consideration of:

-

the structure and organisation of the multinational group and how this influences the context in which the multinational operates;

-

how value is generated by the group as a whole;

-

the interdependencies of the functions performed by the associated enterprises with the rest of the group;

-

the contribution that the associated enterprises make to that value creation; and

-

the legal rights and obligations of each of the parties in performing their functions;

•

the value and nature of assets used, including the value of intangibles and financial assets, the age, market value, locations and property right protections available (see paragraph 1.54 of the 2015 Recommendations);

•

the level of risk assumed by each entity, the functions performed that are effected by that risk and the allocation of risk to those functions - Chapter D.1.2.1 of the 2015 Recommendations provides a six step process for determining this; and

•

where activities are highly fragmented, the extent of interdependence and co-ordination (see paragraph 1.55 of the 2015 Recommendations).

1.126 Significantly, while one party may provide a large number of functions relative to that of the other party to a transaction, it is the economic significance of those functions in terms of their frequency, nature, and value to the respective parties to the transaction that is important.

Profits reasonably reflect the economic substance of the entity's activities

1.127 Once the economically significant activities of the entity have been identified, the sufficient economic substance test requires a determination of whether the profits made by that entity reasonably reflects the economic substance of those activities.

1.128 In determining whether an amount of profit reasonably reflects the economic substance of the entity's activities, regard may be had to the Transfer Pricing Methods contained in Chapter Two of the OECD Transfer Pricing Guidelines to the extent they are relevant.

1.129 In determining whether the profit made as a result of the scheme by each entity reasonably reflects the economic substance of the entity's activities in connection with the scheme, all the components of the profit will be relevant. That is, it will be necessary to consider the components of the profit, being the income itself and the related expenses in determining whether the profit (comprising the income and related expenses) of each entity reasonably reflects the economic substance of the entity's activities (based on the actual functions, assets and risks assumed, rather than contractual activities or functions of the entity).

Reliance on existing transfer pricing documentation

1.130 The sufficient economic substance test requires a broad examination of the scheme and each associated entity's role in connection with that scheme.

1.131 For example, an Australian entity may possess transfer pricing documentation which indicates it is within the lower end of a range of arm's length pricing outcomes based on a cost plus methodology when compared to unrelated party transactions in the market. However, the counterparty associate entity in a low tax jurisdiction may be receiving a disproportionately high amount of income when looked at in the context of the global supply chain, notwithstanding that the main economically significant activities relating to the transaction are carried out in Australia.

1.132 Accordingly, in applying the sufficient economic substance test, it is necessary to examine the functions, assets and risks not only of the relevant Australian taxpayer, but also other Australian and offshore associates connected to the scheme.

1.133 The application of sufficient economic substance test is not intended to impose a significantly larger compliance or evidentiary burden over what would already be required to be prepared by multinational groups for local transfer pricing requirements that properly reflect the OECD Transfer Pricing Guidelines.

1.134 In practice, there is likely to be significant overlap with the analysis a multinational group should be undertaking to substantiate the substance of their arrangements and profits in light of the OECD Transfer Pricing Guidelines.

1.135 However, transfer pricing documentation that does not properly reflect the substance of the arrangement or the role of the entity in that arrangement, having regard to the most recent OECD Transfer Pricing Guidelines, might not provide sufficient evidence to satisfy the test in the absence of additional evidence.

Examples of the operation of the sufficient economic substance test

1.136 An example of an arrangement where the sufficient economic substance test might apply to exclude the relevant taxpayer from the DPT is the transfer of actual functions from the relevant taxpayer to an offshore associate, where the profit made by the offshore associate is commensurate with the functions transferred.

1.137 There are certain types of activities which may indicate that there could be sufficient economic substance concerns. Examples of these may include:

•

where a disproportionate amount of income is being allocated to the holding of assets or assumption of risks by an associate entity, when the economically significant or value-adding functions relating to those risks or assets are carried out in Australia; or

•

where the purported activities carried on by an associated entity and the relevant taxpayer as allocated under a written contract do not align with the actual activities (or scale of activities) carried out by that entity, such that the offshore entity is receiving a disproportionate amount of income relative to the actual activities undertaken.

Example 1.10

Aus Co is a multinational Australian headquartered group that decides to move its marketing and distribution functions to Foreign Co, an entity who is tax resident in a jurisdiction with a 17 per cent tax rate.

There are few commercial reasons provided as evidence for moving those functions to Foreign Co and the tax benefit of the transaction (due to the lower overseas corporate tax rate) outweighs the non-tax financial benefits.

Aus Co has relocated 100 experienced staff to Foreign Co and employed 50 more staff locally in Foreign Co. Aus Co is able to demonstrate that:

•

the staff located in Foreign Co actually carry out the marketing and distribution function for Aus Co; and

•

these functions are no longer carried out in Australia.

Therefore, Aus Co is able to demonstrate that the profits made by Foreign Co and Aus Co reasonably reflect the economic substance of the functions carried out by each entity.

Accordingly, the sufficient economic substance is passed and the DPT will not apply.

Example 1.11

The facts are the same as in Example 1.10 except that Aus Co has not relocated any staff to Foreign Co. Although Foreign Co has over 3,000 employees, only 20 nominated staff provide marketing and distribution functions for the Australian entity.

Evidence suggests that, in substance, many of the value adding marketing and distribution activities are still undertaken by the Australian entity.

In these circumstances it is reasonable to conclude that the profits made by Foreign Co and Aus Co in relation to the marketing services provided do not reasonably reflect the economic substance of either entity's activities, based on the actual activities undertaken by both Aus Co and Foreign Co. Consequently, the sufficient economic substance test is not satisfied.

Example 1.12

The Ozcom group is a multinational electronic hardware group headquartered in Australia that develops, manufactures and markets specialist communications hardware. The Ozcom group has substantial operations in a number of markets globally and has annual global income exceeding $AU1 billion. Ozcom Australia is the parent company of the group.

Ozcom Australia had previously adopted a model where on commercialisation of their products, manufacturing would be undertaken by a related party of the group (Manufacture Co) based in Country A on a toll manufacture basis. Manufacture Co was compensated on a cost plus basis. Ozcom Australia would perform ongoing research and development and other activities to maintain the value of the intellectual property, as well as marketing and distribution functions.

Ozcom Australia restructures its operational model. When a new Ozcom Australia product ('Trumpet') reached commercialisation, a new scheme was put in place. A new wholly owned subsidiary of Ozcom Australia, Foreign IP Co, was established in Country A. Foreign IP Co:

•

purchases the Trumpet intellectual property rights from Ozcom Australia;

•

subcontracts its manufacture on a toll basis to Manufacture Co; and

•

subcontracts the intellectual property support, marketing and distribution of the Trumpet product to Ozcom Australia.

Both Manufacture Co and Ozcom Australia are compensated on a cost plus basis.

Following the restructure, sales of Trumpet are $100 million annually. Manufacture Co receives $44 million ($40 million costs plus 10 per cent) in income for manufacturing on behalf of Foreign IP Co. Ozcom Australia receives $11 million annually ($10 million costs plus 10 per cent) for ongoing intellectual property support, in house marketing and distribution functions it performs.

Following the lodgement of Ozcom Australia's income tax return, to establish the economic substance of the scheme, the Commissioner requests information to determine if each entity is receiving income in accordance with the:

•

the active functions being undertaken by each entity;

•

the assets being actively used in deriving the income from the scheme; and

•

the active management by, and capacity for each entity to assume and absorb the commercial risks.

The functions, assets and risks of the scheme as a whole are as follows.

•

Functions

-

intellectual property development and maintenance, market development and servicing, manufacturing and distribution.

•

Assets:

-

Trumpet intellectual property, intellectual property associated with customer knowledge and Ozcom brand goodwill;

-

manufacturing property plant and equipment; and

-

other business assets in relation to manufacturing, marketing and distribution.

•

Risks

-

obsolesce of Trumpet intellectual property, loss of brand goodwill, commercial loss from the development, manufacture and sale of the Trumpet product.

Based on an analysis of the activities of each of the entities in connection with the scheme, the taxpayer fails to demonstrate sufficient economic substance. The Commissioner considers the $45 million income attributed to Foreign IP Co does not reasonably reflect the active functions undertaken by Foreign IP Co, the assets held or risks actively managed by Foreign IP Co.

On the basis of the available information, it would not be reasonable to conclude that income attributed to Foreign IP Co reasonably reflects sufficient economic substance of the entity's activities in connection with the scheme.

Example 1.13

The facts are the same as in Example 1.12, except for the following.

•

Foreign IP Co acquires the Trumpet intellectual property but also takes on the marketing, distribution and intellectual property maintenance functions, transferring key personnel from Australia and developing local capacity.

•

Although a wholly owned subsidiary of Ozcom Australia, Foreign IP Co substantially funds the scheme through external borrowing for which Australia Co does not provide a guarantee.

•

Despite repeated requests from the Commissioner, Ozcom Australia has not provided supporting information in relation to the relevant functions, assets and risks being undertaken by each entity in the scheme.

Following the lodgement of Ozcom Australia Co's income tax return, to establish the economic substance of the scheme, the Commissioner attempts to assess each entity's income received in accordance with the relevant functions, assets and risks of that entity. Despite several requests by the Commissioner, Ozcom Australia Co does not provide relevant information that would assist the Commissioner in this assessment.

In this case, Foreign IP Co:

•

has paid for the intellectual property development;

•

has taken on the marketing, distribution and intellectual property maintenance functions;

•

owns the assets of the scheme; and

•

together with its debtors, is subject to the commercial risk.

If this information had been provided to the Commissioner, the Commissioner could have considered that the income attributed to Foreign IP Co reasonably reflects the active functions undertaken by its staff, and its assets and risks.

However, as Ozcom Australia has not provided any supporting information to the Commissioner, it fails to establish the substance of the scheme. Therefore, based on information available to the Commissioner at the time, it would not be reasonable to conclude that the scheme has sufficient economic substance.

DPT does not limit the operation of other provisions

1.138 If the DPT applies to a scheme, there is no limitation on applying other anti-avoidance provisions in Part IVA of the ITAA 1936 to the scheme.

[Schedule 1, item 13, paragraph 177J(8)(a) of the ITAA 1936]

1.139 Similarly, if another anti-avoidance provisions in Part IVA of the ITAA 1936 applies to a scheme, there is no limitation on applying the DPT to the scheme. However, it is not intended that double taxation would arise in respect of the same scheme.

[Schedule 1, item 13, paragraph 177J(8)(b) of the ITAA 1936]

Consequences that arise if the DPT applies

Liability to pay DPT arises

1.140 If the DPT applies to a taxpayer, the Commissioner may make a DPT assessment and issue it to the relevant taxpayer. The amount of diverted profit on which tax is imposed is:

•

if there is one DPT tax benefit in respect of the taxpayer for the relevant income year - the DPT base amount for that DPT tax benefit; or

•

if there is more than one DPT tax benefit in respect of the taxpayer for the relevant income year - the sum of the DPT base amounts for those DPT tax benefits.

[Schedule 1, item 13, paragraph 177N(a) and subsection 177P(1) of the ITAA 1936]

1.141 The DPT base amount is:

•

if the DPT tax benefit is a tax benefit that relates to the amount of assessable income, the amount of an allowable deduction, the amount of a capital loss or an amount that is subject to withholding tax - the amount of the DPT tax benefit; or

•

if the DPT tax benefit is a tax benefit that relates to the amount of a foreign income tax offset, an innovation tax offset, or an exploration credit - the amount of the DPT tax benefit divided by the standard Australian corporate tax rate.

[Schedule 1, items 6 and 13, definition of 'DPT base amount' in subsection 177A(1), subsection 177P(2) of the ITAA 1936]

1.142 Tax is payable on the amount of diverted profit at a rate of 40 per cent. This penalty tax rate has been set to encourage taxpayers to pay the lower corporate tax rate through complying with Australia's tax rules.

1.143 The DPT will be imposed by, and the rate set at 40 per cent in, the Diverted Profits Tax Act 2017.

[Schedule 1, item 41, definition of 'diverted profits tax' in subsection 995-1(1) of the ITAA 1997; sections 3 and 4 of the Diverted Profits Tax Act 2017]

1.144 The DPT is due and payable by the relevant taxpayer at the end of 21 days after the Commissioner issues a notice of assessment of the amount of DPT for the relevant income year.

[Schedule 1, item 13, subsection 177P(3) of the ITAA 1936]

1.145 The DPT due and payable will not be reduced by the amount of foreign tax paid on the diverted profits. In this regard, a non-refundable tax offset arises if a taxpayer pays foreign income tax on an amount of assessable income (Division 770 of the ITAA 1997). Tax offsets (including foreign income tax offsets) can only be applied against a taxpayer's basic income tax liability (section 63-10 of the ITAA 1997). Therefore, a foreign income tax offset cannot be applied to reduce a liability to DPT.

1.146 If a taxpayer is liable to pay DPT, an income tax deduction is not allowed for the amount of DPT paid (subsection 5-5(2) of the ITAA 1997).

1.147 Subdivision 284-C of Schedule 1 to the TAA 1953 specifies penalties that generally apply to schemes to which Part IVA of the ITAA 1936 applies. These penalties will not apply when a DPT assessment is made because the 40 per cent DPT rate is taken to incorporate a penalty component.

1.148 When Part IVA of the ITAA 1936 applies to a scheme, the Commissioner currently may cancel the tax benefit (under section 177F) and make an amended income tax assessment. However, where the Commissioner is applying Part IVA solely because of section 177J, the Commissioner will be unable to make a determination under subsection 177F(1) or (2A) to cancel a tax benefit in relation to a scheme. [Schedule 1, item 13, paragraph 177N(b) of the ITAA 1936]

1.149 However, this does not prevent the Commissioner from making a determination to cancel a tax benefit relating to the scheme because the general anti-avoidance rule (section 177D of the ITAA 1936) or the multinational anti-avoidance law (section 177DA) applies to scheme.

1.150 If the Commissioner has made a DPT assessment in respect of a taxpayer in relation to a scheme to which Part IVA applies, the Commissioner will be able to make a determination under subsection 177F(3). Consequently, the Commissioner will be able to make a compensating adjustment to prevent double taxation arising because of the DPT assessment.

[Schedule 1, item 11, subsection 177F(3) of the ITAA 1936]

Shortfall interest charge

1.151 If the Commissioner gives a DPT assessment to an entity, the entity will be liable to pay shortfall interest charge equal to the amount of shortfall interest charge that would be payable had the Commissioner issued an amended income tax assessment (rather than a DPT assessment).

[Schedule 1, items 44 to 49, section 280-1, section 280-50 and subsection 280-102C(1) and (2) of Schedule 1 to the TAA 1953]

1.152 Consequently, shortfall interest charge will be payable for each day in the period:

•

beginning at the start of the day on which income tax under the entity's notice of assessment of income tax for that income year was due to be paid, or would have been due to be paid if there had been any; and

•

ending at the end of the day before the day on which the Commissioner gave the entity notice of the DPT assessment.

1.153 Shortfall interest charge is due and payable 21 days after the day on which the Commissioner gives notice of the charge.

[Schedule 1, item 13, section 177R of the ITAA 1936]

1.154 The rate of shortfall interest charge is 3 percentage points above the base interest rate (section 280-105 of Schedule 1 to the TAA 1953). The base interest rate is the 90-day bank accepted bill rate (subsection 8AAD(2) of the TAA 1953).

General interest charge

1.155 If an amount of DPT or shortfall interest charge that an entity is liable to pay remains unpaid after the time by which it is due to be paid, the entity will be liable to pay general interest charge on the unpaid amount for each day in the period that:

•

starts at the beginning of the day by which the amount was due to be paid; and

•

finishes at the end of the last day on which, at the end of the day, any amount of the DPT, shortfall interest charge or general interest charge remains unpaid.

[Schedule 1, item 13, section 177Q of the ITAA 1936]

1.156 General interest charge is calculated daily on a compounding basis. The general interest charge rate for a day is worked out by dividing the base interest rate plus 7 per cent by the number of days in the calendar year (section 8AAD of the TAA 1953).

Franking credits arise when DPT paid

1.157 A franking credit will arise on the day that an entity pays DPT. The amendments to the imputation system which specify the way to work out the amount of the franking credit that arises when an entity pays DPT are explained later in this Chapter.

The DPT assessment and review process

1.158 The administrative provisions supporting the DPT are designed to ensure that large multinational groups operating in Australia comply with their Australian tax obligations, and to incentivise these groups to cooperate fully with the Commissioner.

1.159 These provisions, in combination with the DPT provisions, have the object of encouraging significant global entities to provide sufficient information to the Commissioner to allow the timely resolution of disputes about Australian tax.

[Schedule 1, item 13, subsection 177H(2) of the ITAA 1936]

DPT assessments

1.160 The Commissioner may make a DPT assessment at any time within 7 years of first serving a notice of assessment on the taxpayer for an income year.

[Schedule 1, item 9, section 145-10 of Schedule 1 to the TAA 1953]

1.161 The Australian Taxation Office (ATO) will ensure a rigorous framework is introduced for the DPT that encompasses several levels of oversight, senior executive sign-off and additional safeguards so as to provide assurance around the DPT process. This is to ensure that the DPT will only be applied in very limited circumstances and is focused on tax avoidance arrangements by related parties to divert profits offshore. The Commissioner will establish a Panel (similar to the existing General Anti-avoidance Rule Panel) relating to DPT that will include at least one external member. Except in very limited circumstances, the Commissioner will seek endorsement from the Panel to make a DPT assessment. The Commissioner will outline the ATO's administrative processes through guidance.

1.162 The generic assessment rules in Division 155 of Schedule 1 to the TAA 1953 will apply to an amount of DPT. However, modifications are made to these generic rules to reflect special features that apply to amounts of DPT.

[Schedule 1, items 44 and 45, sections 145-5, 145-10, 145-15, 145-20 and 155-5 of Schedule 1 to the TAA 1953]

1.163 If the Commissioner makes a DPT assessment, the Commissioner must give the taxpayer notice of the assessment as soon as practicable after the assessment is made (section 155-10 of Schedule 1 to the TAA 1953).

1.164 The production of a notice of a DPT assessment will be conclusive evidence that the assessment was properly made and, except on appeal to the Federal Court of Australia, that the amounts and particulars of the assessment are correct (subsection 350-10(1) of Schedule 1 to the TAA 1953).

Payment of DPT liability amount

1.165 The DPT is due and payable by the relevant taxpayer at the end of 21 days after the Commissioner issues a notice of assessment of the amount of DPT for the relevant income year [Schedule 1, item 13, subsection 177P(3) of the ITAA 1936]

Period of review of DPT assessments

1.166 If the Commissioner gives an entity a notice of a DPT assessment for an amount of DPT, a period of review for the DPT assessment will apply. The period will generally:

•

start on the day on which the Commissioner gives the entity a notice of a DPT assessment; and

•

end 12 months after that day.

[Schedule 1, item 44, paragraph 145-15(1)(a) of Schedule 1 to the TAA 1953]

1.167 The period of review gives the taxpayer the opportunity to provide additional documents and information to the Commissioner relating to the DPT assessment.

1.168 The period of review can be shortened if:

•

the taxpayer, by written notice given to the Commissioner, specifies a shorter period; or

•

the Federal Court of Australia has not made an order under subsection 145-15(3) in respect of the written notice.

[Schedule 1, item 44, paragraph 145-15(1)(b) of Schedule 1 to the TAA 1953]

1.169 Therefore, for example, if the taxpayer considers that the Commissioner has been provided with all relevant information and documents relating to the DPT assessment, notice can be given to shorten the period of review in the interests of resolving the dispute in an expedient manner.

1.170 The notice must be in writing and must specify a shorter period of review:

•

starting on the day on which the Commissioner gives the entity a notice of a DPT assessment; and

•

ending on a day that is at least 30 days after the day on which the entity gives the written notice to the Commissioner.

[Schedule 1, item 44, subsection 145-15(2) of Schedule 1 to the TAA 1953]

1.171 Unless the Commissioner applies to the Federal Court under subsection 145-15(3), the period will end on the date specified in the notice.

1.172 If the Commissioner is of the view that further time is required to obtain information and documents, and/or review the DPT assessment, the Commissioner may apply to the Federal Court for an order in respect of the notice. The Federal Court has a wide power to make orders in respect of the notice, including for example an order that the period of review does not end on the date specified in the notice.

1.173 The Federal Court may make an order under subsection 145-15(3) in respect of the written notice if:

•

the Commissioner has started to examine the entity's affair's in relation to the DPT assessment;

•

the Commissioner has not completed the examination within the shorter period specified in the notice;

•

the Commissioner, within 30 days after the day on which the entity gives the notice to the Commissioner, applies to the Court for the order; and

•

the Court is satisfied that it was not reasonably practicable, or it was inappropriate, for the Commissioner to complete the examination within the shorter period specified in the notice, because of:

-

any action taken by the entity; or

-

any failure by the entity to take action that it would have been reasonable for the entity to take.

[Schedule 1, item 44, subsection 145-15(3) of Schedule 1 to the TAA 1953]

1.174 This ensures that the period of review cannot be terminated prematurely by the taxpayer if, for example:

•

the taxpayer provides information to the Commissioner at the same time as, or shortly before, it gives a notice to the Commissioner, and the Commissioner needs additional time to properly examine material; or

•

the Commissioner makes a reasonable request for the entity to provide additional information in relation to the DPT assessment before the notice is given to the Commissioner, and the entity has not complied with that request.

1.175 The period of review can be extended if:

•

the entity or the Commissioner applies to the Federal Court to extend the period of review, and the Federal Court consents to the extension (subsection 155-35(3) of Schedule 1 to the TAA 1953); or

•

the entity consents to a request by the Commissioner for an extension of the period of review (subsection 155-35(4) of Schedule 1 to the TAA 1953).

[Schedule 1, item 44, paragraph 145-15(1)(c) of Schedule 1 to the TAA 1953]

1.176 An order by the Federal Court to extend the period of review, or an extension by consent of the entity, can only be made once.

[Schedule 1, item 44, subsection 145-15(4) of Schedule 1 to the TAA 1953]

1.177 Generally, for the types of entities within scope of the DPT, there is a four year period to review assessments. The shortened period of review for DPT assessments reflects the requirement for the entity to pay the amount of the liability for DPT upfront.

1.178 During the period of review, the entity will have the opportunity to provide the Commissioner with additional information relating to the DPT assessment. As a result of receiving the additional information, the Commissioner may:

•

make no change to the DPT assessment;

•

amend the DPT assessment to reduce the liability to DPT; or

•

amend the DPT assessment to increase the liability to DPT.

Amendment to reduce a liability to DPT

1.179 If, as a result of receiving additional information from the entity, the Commissioner is satisfied that the DPT assessment is excessive, or if the relevant taxpayer self-amends its income tax assessment during the review period to reduce the DPT tax benefit, the Commissioner can make an amended DPT assessment to reduce the amount of the liability to DPT.

1.180 If the amount of the liability for DPT is reduced, interest will be payable on the amount of DPT refunded - that is, on the overpayment of the DPT.

[Schedule 1, items 50 and 51, definition of 'diverted profits tax' in subsection 3(1) and item 30 of the table in section 3C of the Taxation (Interest on Overpayments and Early Payments) Act 1983]

1.181 The rate of interest on the overpayment of the DPT is the base interest rate (section 10 of the Taxation (Interest on Overpayments and Early Payments) Act 1983). The base interest rate is the 90-day bank accepted bill rate (subsection 8AAD(2) of the TAA 1953).

1.182 In reviewing a DPT assessment, the Commissioner may agree to an outcome with the entity that involves both:

•

an amendment to reduce a DPT assessment; and

•

an amendment to increase an income tax assessment.

1.183 The period for amending an income tax assessment to increase an income tax liability is extended to facilitate this outcome beyond the normal four year amendment period.

[Schedule 1, items 4 and 5, subsection 170(12) and definitions of 'diverted profit tax' and 'DPT assessment' in subsection 170(14) of the ITAA 1936]

1.184 However, in these circumstances, the Commissioner may restore the DPT assessment if:

•

the entity subsequently self-amends the income tax assessment; or

•

the Commissioner allows an objection to amend the income tax assessment.

Example 1.14

Soft Co is a global manufacturer with a subsidiary in Australia (Australia Co) that undertakes sales and distribution services for the group. The group restructures and sets up a subsidiary in a low tax jurisdiction (Foreign Co) and routes all of the goods sold across the region through Foreign Co. Australia Co is a reseller of the goods and purchases the goods at a higher price from Foreign Co, than it previously did when it dealt directly with Soft Co. The contractual arrangements purport that Foreign Co provides significant marketing, distribution and back office services in order to justify the additional mark up. However in substance, Australia Co undertakes many of these services for sales to Australian customers.

Australia Co currently receives a 5 per cent margin on product sales (being $5 million per year).

Based on the information available, the Commissioner is of the view the principal purpose of the restructure is to obtain a tax benefit - namely, understatement of Australian income. The Commissioner has concerns whether the subsidiary has economic substance. As Australia Co does not provide the Commissioner with any further information or documents supporting its transfer pricing position:

•

the Commissioner concludes, on the basis of limited information available, that the income attributed to Australia Co would have been $30 million if the Australia Co had purchased the goods directly from Soft Co;

•

the DPT tax benefit is therefore $25 million ($30 million - $5 million income); and

•

the DPT is imposed at a penalty rate of 40 per cent on the $25 million DPT tax benefit - this results in a DPT liability of $10 million ($25 million x 40 per cent) which Australia Co must pay within 21 days.

Over the review period, Soft Co provides more information to the Commissioner that supports that the income of Australia Co should be $20 million (rather than $30 million) and the DPT tax benefit is revised to $15 million ($20 million - $5 million income). Accordingly, the DPT assessment would be amended to $6 million ($15 million x 40 per cent).

Australia Co could self-amend its Australian income tax assessment to recognise the $15 million additional income and pay income tax at the 30 per cent rate (being $4.5 million additional tax plus penalties and interest). Australia Co's DPT liability would then be reduced to nil.

Amendment to increase a liability to DPT

1.185 As a result of reviewing the additional information provided by the entity, the Commissioner may conclude that the amount of DPT should be increased. In this event, the Commissioner can issue an amended DPT assessment to increase the amount of the liability to DPT.

1.186 If the amount of the liability to DPT is increased, shortfall interest charge will be payable on the additional amount of DPT that the relevant taxpayer is liable to pay.

[Schedule 1, items 47 to 49, section 280-1, section 280-50 and subsections 280-102C(3) to (5) of Schedule 1 to the TAA 1953]

1.187 Shortfall interest charge will be payable for each day in the period:

•

beginning at the start of the day on which DPT under the entity's notice of assessment of DPT for that income year was due to be paid, or would have been due to be paid if there had been any; and

•

ending at the end of the day before the day on which the Commissioner gave the entity notice of the amended DPT assessment.

[Schedule 1, item 49, subsection 280-102C(4) of Schedule 1 to the TAA 1953]

1.188 However, if an amended assessment reinstates all or part of a liability in relation to a particular that had been reduced by an earlier amended assessment, the period for the reinstated liability begins at the start of the day on which diverted profits tax under the earlier amended assessment was due to be paid.

[Schedule 1, item 49, subsection 280-102C(5) of Schedule 1 to the TAA 1953]

1.189 Shortfall interest charge is due and payable 21 days after the day on which the Commissioner gives notice of the charge.

[Schedule 1, item 13, section 177R of the ITAA 1936]

1.190 The rate of shortfall interest charge is 3 percentage points above the base interest rate (section 280-105 of Schedule 1 to the TAA 1953).

Review of DPT assessments

1.191 The rights of taxpayers to make a taxation objection against a taxation decision (including an assessment) are set out in Part IVC of the TAA 1953. However, the relevant taxpayer is prevented from making a taxation objection against an assessment of DPT in the manner set out in Part IVC during the period of review.

[Schedule 1, item 44, section 145-20 of Schedule 1 to the TAA 1953]

1.192 This ensures that the Commissioner is given adequate time to consider information that the relevant taxpayer gives to the Commissioner in the period of review.

1.193 The relevant taxpayer will be able to make a taxation objection against an assessment of DPT in the manner set out in Part IVC within 60 days of the end of the period of review.

[Schedule 1, item 44, paragraph 145-20(4)(c) of Schedule 1 to the TAA 1953]

1.194 The operation of Part IVC in relation to DPT assessments is modified to specify that the taxation objection must be an appeal to the Federal Court (and not to the Administrative Appeals Tribunal).

[Schedule 1, items 1 and 44, paragraph (e) of Schedule 1 to the Administrative Decisions (Judicial Review) Act 1977 and section 145-20 of Schedule 1 to the TAA 1953]

1.195 In addition, if an appeal is made to the Federal Court against a DPT assessment, restricted DPT evidence is not admissible in evidence in the proceedings.

[Schedule 1, item 44, section 145-25 of Schedule 1 to the TAA 1953]

1.196 Restricted DPT evidence is any information or documents that the relevant taxpayer does not provide to the Commissioner during the period of review, or that the Commissioner did not already have prior to the period of review. That is, restricted DPT evidence is information or documents that:

•

the relevant taxpayer, or an associate (within the meaning in section 318 of the ITAA 1936) of the relevant taxpayer, had in its custody or under its control at a time before, during or after the period of review; and

•

the Commissioner did not have in his or her custody or control during the period of review.

[Schedule 1, items 43 and 44, definition of 'restricted DPT evidence' in subsection 995-1(1) of the ITAA 1997, subsection 145-25(2) of Schedule 1 to the TAA 1953]

1.197 The effect of this evidentiary restriction is that any information or documents that the taxpayer does not provide to the Commissioner during the period of review for a DPT assessment will generally not be admissible on behalf of the taxpayer in an appeal against the DPT assessment.

[Schedule 1, item 44, section 145-25 of Schedule 1 to the TAA 1953]

1.198 This evidentiary restriction will encourage a taxpayer that has been issued a DPT assessment to provide the Commissioner with complete and accurate documents and information, and to make genuine attempts to provide and obtain relevant information, during the period of review.

1.199 However, restricted DPT evidence is admissible if:

•

the Commissioner consents to its admission - the consent must be in writing, and the Commissioner must give a copy of the consent to the relevant taxpayer as soon as practicable after the decision to give consent is made;

•

with leave of the court if the court considers that its admission is in the interests of justice; or

•

the restricted DPT evidence is expert evidence that comes into existence after the period of review and is based on evidence that the Commissioner had in his or her custody or control or under his or her custody or control at any time in the period of review.

[Schedule 1, item 44, subsections 145-25(3), (7) and (8) of Schedule 1 to the TAA 1953]

1.200 In making a decision whether to consent to the admission of DPT restricted evidence, the Commissioner or a court must have regard to:

•

if the restricted DPT evidence were not admissible in evidence in the proceedings, whether the remaining information or documents that are relevant to the proceedings are, or are likely to be, misleading; and

•

whether it would have been reasonable for the relevant taxpayer, or an associate (within the meaning in section 318 of the ITAA 1936) of the relevant taxpayer, to have given the Commissioner the restricted DPT evidence within the period of review.

[Schedule 1, item 44, subsection 145-25(5) of Schedule 1 to the TAA 1953]

1.201 The Commissioner must give consent to the admission of restricted DPT evidence if failure to do so would have the effect, for the purposes of the Constitution, of making any tax or penalty incontestable.

[Schedule 1, item 44, subsection 145-25(6) of Schedule 1 to the TAA 1953]

1.202 The consent must be in writing. The Commissioner must give the entity that is subject to the DPT assessment a copy of the consent as soon as practicable after the consent is given.

[Schedule 1, item 44, subsections 145-25(7) and (8) of Schedule 1 to the TAA 1953]

Amendments to the imputation system

Franking debits arise when DPT is paid

1.203 A franking credit will arise on the day that an entity pays DPT provided that:

•

the entity meets the residency requirement that applies for imputation purposes for the income year in which the DPT is paid; and

•

the entity is a franking entity for the whole or part of that income year.

[Schedule 1, item 14, item 8 of the table in subsection 205-15(1) of the ITAA 1997]

1.204 For these purposes, an entity pays diverted profits tax if the entity has a liability to pay DPT and:

•

the entity makes a payment to satisfy the liability (in whole or in part); or

•

a credit, or a running balance account surplus, is applied to discharge or reduce the liability.

[Schedule 1, items 16 to 18 and 41, section 205-20 and definition of 'pays diverted profits tax' in subsection 995-1(1) of the ITAA 1997]

1.205 The amount of the franking credit that arises is equal to the amount worked out as follows:

•

work out that part of the DPT payment that is attributable to the period during which the entity is a franking entity; and

•

multiply this amount by the standard corporate tax rate (as defined in Part IVA of the ITAA 1936) divided by 40 per cent.

[Schedule 1, items 14 and 15, item 8 of the table in subsection 205-15(1) and subsection 205-15(5) of the ITAA 1997]

1.206 As a result, if an entity that is a franking entity pays DPT, a franking credit will arise in the entity's franking account equal to the amount that would arise if the entity paid DPT at the standard corporate tax rate (rather than at the DPT rate). This reflects the fact that the DPT rate includes a penalty component.

1.207 The standard corporate tax rate is defined in section 177A of the ITAA 1936 to mean the rate of tax in respect of a company covered by paragraph 23(2)(b) of the Income Tax Rates Act 1936 - that is, 30 per cent.

[Schedule 1, item 6, definition of 'standard corporate tax rate' in subsection 177A(1) of the ITAA 1936]

1.208 Amendments in the Treasury Laws Amendment (Enterprise Tax Plan) Bill 2016 will reduce the standard company tax rate from 1 July 2023. Therefore, when that amendment comes into effect, a consequential amendment will modify the definition of standard corporate tax rate.

[Schedule 1, item 7, definition of 'standard corporate tax rate' in subsection 177A(1) of the ITAA 1936]

Example 1.15

Company A is liable to pay DPT of $200,000. Company A:

•

meets the residency requirement that applies for imputation purposes for the income year in which the DPT is paid; and

•

is a franking entity for the whole of that income year.

When Company A pays the DPT liability, a franking credit of $150,000 will arise in its franking account, worked out as follows:

•

as Company A is a franking entity for the whole of the income year, the whole of the DPT payment ($200,000) is attributable to the period during which Company A is a franking entity;

•

$200,000 x (30 per cent / 40 per cent) = $150,000.

Franking debits arise when DPT is refunded

1.209 A franking debit arises on the day that an entity receives a refund of DPT provided that:

•

the entity meets the residency requirement that applies for imputation purposes for the income year to which the refund relates; and

•

the entity is a franking entity during the whole or part of that income year.

[Schedule 1, item 19, item 13 of the table in subsection 205-30(1) of the ITAA 1997]

1.210 For these purposes, an entity receives a refund of diverted profits tax if:

•

the entity receives an amount as a refund, or the Commissioner applies a credit or a running balance account surplus against a liability or liabilities of the entity; and

•

the refund of the amount, or the application of the credit, represents in whole or in part a return to the entity of an amount paid to satisfy the entity's liability to pay DPT.

[Schedule 1, items 21 to 23 and 43, section 205-35 and definition of 'receives a refund of diverted profits tax' in subsection 995-1(1) of the ITAA 1997]

1.211 The amount of the franking debit is equal to the amount worked out as follows:

•

work out that part of the refund that is attributable to the period during which the entity is a franking entity;

•

multiply this amount by the standard corporate tax rate divided by 40 per cent.

[Schedule 1, items 4, and 15, item 13 of the table in subsection 205-30(1) and subsection 205-30(3) of the ITAA 1997]

1.212 As a result, if an entity that is a franking entity receives a refund of DPT, a franking debit will arise in the entity's franking account equal to the amount that would arise if the DPT rate was equal to the corporate tax rate.

Example 1.16

Company A receives a refund of DPT of $200,000. Company A:

•

meets the residency requirement that applies for imputation purposes for the income year to which the refund relates; and

•

is a franking entity during the whole of that income year.

When Company A receives a refund of DPT, a franking debit $150,000 will arise in its franking account, worked out as follows:

•

as Company A is a franking entity for the whole of the income year, the whole of the DPT payment ($200,000) is attributable to the period during which Company A is a franking entity;

•

$200,000 x (30 per cent / 40 per cent) = $150,000.

Consequential amendments to the imputation system

1.213 A range of consequential amendments are made to imputation system to ensure that these outcomes are reflected in the imputation provisions that relate to:

•

exempting accounts and franking accounts of exempting entities and former exempting entities;

•

franking returns;

•

franking assessments; and

•

life insurance companies.

[Schedule 1, items 24 to 38, sections 208-115, 208-120, 208-130, 208-145, 214-45, 214-150, 219-15 and 219-30 of the ITAA 1997]

Consequential amendments

Consolidation

1.214 As a result of the single entity rule, a tax consolidated group is taxed as a single entity (including for the purposes of applying the DPT). However, consequential amendments are made to:

•

ensure that the imputation provisions operate appropriately when a refund of DPT is made to a former member of a consolidated group; and

•

ensure that a DPT liability is a tax-related liability, so that the joint and several liability rules and the tax sharing agreement rules apply to the DPT liability.

[Schedule 1, items 39 and 40, paragraph 709-100(1)b) and item 115 of the table of tax-related liabilities in subsection 721-10(2) of the ITAA 1997]

Other consequential amendments

1.215 Other consequential amendments:

•

modify the definition of assessment in subsection 6(1) of the ITAA 1936 to specify that an assessment includes a DPT assessment;

•

modify various provisions in Part IVA of the ITAA 1936 to make appropriate references to the DPT provisions;

•

insert a note in the definition of period of review in subsection 995-1(1) to refer to the modified period of review for DPT assessments; and

•

modify the table of tax-related liabilities in section 250-10 of Schedule 1 to the TAA 1953 to ensure that a liability to DPT, and a liability to shortfall interest charge for DPT, are tax-related liabilities.

[Schedule 1, items 2, 8 to 10, 12, 42 and 46, subsections 6(1), 177A(5), 177CB(5), 177F(5A) and 177F(5B) of the ITAA 1936, definition of 'period of review' in subsection 995-1(1) of the ITAA 1997, and section 250-10 of Schedule 1 to the TAA 1953]

Application and transitional provisions

1.216 The DPT will apply in relation to DPT tax benefits for an income year that starts on or after 1 July 2017 (whether or not the DPT tax benefit arises in connection with a scheme that was entered into, or was commenced to be carried out, before 1 July 2017). [Schedule 1, item 52]

1.217 By applying the DPT to a DPT tax benefit that arises in connection with a scheme that was entered into, or was commenced to be carried out, before 1 July 2017, the DPT will operate appropriately to ensure that, going forward, the tax paid by significant global entities properly reflects the economic substance of their activities in Australia.

STATEMENT OF COMPATIBILITY WITH HUMAN RIGHTS

Prepared in accordance with Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011

Diverted profits tax

1.218 This Schedule is compatible with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of the Human Rights (Parliamentary Scrutiny) Act 2011.

Overview

1.219 Schedule 1 to this Bill amends the Income Tax Assessment Act 1936, the Taxation Administration Act 1953 and associated Acts to introduce a new diverted profits tax (DPT). If the diverted profits tax applies, the Diverted Profits Tax Act 2017 will impose tax on the amount of the diverted profit at a tax rate of 40 per cent.

1.220 The DPT aims to ensure that the tax paid by significant global entities properly reflects the economic substance of their activities in Australia and aims to prevent the diversion of profits offshore through contrived arrangements. It will also encourage significant global entities to provide sufficient information to the Commissioner of Taxation to allow for the timely resolution of tax disputes

Human rights implications

1.221 This Schedule does not engage any of the applicable rights or freedoms.

Conclusion

1.222 This Schedule is compatible with human rights as it does not raise any human rights issues.