House of Representatives

Explanatory Memorandum

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

Chapter 1 Toughening the multinational anti-avoidance law

Outline of chapter

1.1 Schedule 1 to this Bill amends the ITAA 1936 to ensure that the multinational anti-avoidance law applies to artificial or contrived arrangements involving trusts and partnerships entered into by multinational entities to avoid the taxation of business profits in Australia.

1.2 All legislative references in this Chapter are references to the ITAA 1936 unless the contrary is specified.

Context of amendments

Operation of existing law

1.3 Schedule 2 to the Tax Laws Amendment (Combating Multinational Tax Avoidance) Act 2015 amended the ITAA 1936 to introduce the multinational anti-avoidance law.

1.4 The multinational anti-avoidance law can result in the general anti-avoidance rules in Part IVA of the ITAA 1936 applying to schemes in which:

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a foreign entity that is a 'significant global entity' derives income from making supplies to Australian customers with the support of an Australian resident entity or an Australian permanent establishment of an entity that is either associated with or commercially dependent on the foreign entity; and

•

some or all of the income is not attributable to a permanent establishment in Australia.

1.5 A 'significant global entity' is, broadly, an entity that either has annual global income of $1 billion or more or is part of a group of entities that are consolidated for accounting purposes and have annual global income of $1 billion or more.

1.6 Consistent with the general framework of Part IVA, for the multinational anti-avoidance law to result in Part IVA applying to a scheme, at least one of the taxpayers involved in entering into or carrying out the scheme must have done so with a principal purpose of obtaining a tax benefit (or both a tax benefit and a reduction in foreign tax liabilities) for a taxpayer or taxpayers.

1.7 Where the multinational anti-avoidance law applies to a scheme, the Commissioner of Taxation has the power to make a determination under Part IVA and apply the tax law in such a way as to undo any tax benefit, including, for example, by treating the foreign entity as if it had been making the relevant supplies through an Australian permanent establishment.

1.8 The quantum of the tax benefit obtained under the scheme will depend on the facts and circumstances of the case. However, it is likely to include the amount of the ordinary and statutory income from the supply that would have been attributable to an Australian permanent establishment of the foreign entity, subject to any compensating adjustments allowing for deductions.

1.9 The quantum of the tax benefit obtained also takes into account obligations arising (for the relevant taxpayer or another taxpayer) under Australia's withholding tax rules.

Budget announcement

1.10 In the 2017-18 Budget, the Government announced amendments to the multinational anti-avoidance law as part of a package of measures to improve the integrity of the tax system.

1.11 The announced amendments are intended to address concerns that entities can avoid the multinational anti-avoidance law applying to a scheme by interposing a trust or partnership. If the interposed entity makes the supply and receives the income before distributing it back to the foreign entity, the multinational anti-avoidance law may not have applied to the scheme prior to the amendments made by this Schedule.

Summary of new law

1.12 Schedule 1 amends the ITAA 1936 to provide that, when determining if the multinational anti-avoidance law applies to a scheme, supplies made and income received by a closely related trust or partnership are treated as being made or received by the foreign entity.

Comparison of key features of new law and current law

Detailed explanation of new law

1.13 Schedule 1 amends the ITAA 1936 to extend the circumstances in which the multinational anti-avoidance law in section 177DA results in the general anti-avoidance rules in Part IVA applying to a scheme.

1.14 As a result of the amendment, when determining if the conditions for the multinational anti-avoidance law to apply to a scheme in subsection 177DA(1) are satisfied:

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supplies made by a trust or partnership to an Australian customer can be treated as being made by a foreign entity to the customer; and

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income derived by a trust or partnership can be treated as being derived by the foreign entity.

[Schedule 1, item 2, subsection 177DA(8)]

1.15 Previously, there were questions about whether the multinational anti-avoidance law would apply if a foreign entity restructured so that its supplies to Australian customers were made through an Australian trust or partnership. This amendment ensures that the application of the multinational anti-avoidance law cannot be avoided by interposing an Australian trust or partnership between the foreign entity and its Australian customers.

Conditions

1.16 In order for this extension to apply, the trust or partnership must have:

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a relationship with a foreign entity that means they are not independent of that entity at the time they make the relevant supply or supplies to their Australian customer; and

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a foreign entity participant (see paragraphs 1.23 to 1.29) at any time in an income year in which income is derived from the supply.

[Schedule 1, item 2, paragraph 177DA(7)(c) and (d)]

1.17 The trust or partnership must also make at least one supply in a year of income to an Australian customer that results in income being derived by the trust or partnership. This condition ensures that the extension only applies if it would be relevant. It does not matter whether the income from the supply is derived in a different year of income to the year in which the supply is made. [Schedule 1, item 2, paragraphs 177DA(7)(a) to (b)]

Lack of independence

1.18 There are three forms of control and mutual dependence that result in a trust or partnership lacking independence at the time the supply is made and therefore satisfying the condition for this extension of the multinational anti-avoidance law to apply.

1.19 One such circumstance is that the trust or partnership is 'connected with' the foreign entity within the meaning of section 328-125 of the ITAA 1997. Two entities are connected with each other if one entity controls the other or both entities are controlled by a third party. In this context, controlling an entity generally means being entitled to at least 40 per cent of any income distribution, capital distribution or voting rights of the entity. [Schedule 1, item 2, subparagraph 177DA(7)(d)(i)]

1.20 Another such circumstance is where the trust or partnership would be an affiliate of the foreign entity within the meaning of section 328-130 of the ITAA 1997 if the trust or partnership were an individual or a company. This means that the trust or partnership would be expected to act at the direction of or in concert with the foreign entity when carrying on its business. [Schedule 1, item 2, subparagraph 177DA(7)(d)(ii)]

1.21 The final circumstance is that the trust or partnership and the foreign entity are both members of a global group within the meaning of Part IVA (i.e. a group of entities consolidated for accounting purposes). [Schedule 1, item 2, subparagraph 177DA(7)(d)(iii)]

1.22 In all of these cases, the trust or partnership and the foreign entity have a sufficiently close relationship that it is reasonable to expect that they may not be acting independently.

Foreign entity participant

1.23 The second requirement for the extension to apply is that the trust or partnership has a foreign entity participant during an income year in which income is derived from the supply, which can occur in two circumstances. [Schedule 1, items 1 and 2, the definition of foreign entity participant in subsection 177A(1) and paragraph 177DA(7)(c)]

1.24 The first circumstance is that a beneficiary of the trust or partner of the partnership during the income year is a foreign entity (within the meaning of the ITAA 1997). [Schedule 1, item 1, paragraph (a) of definition of foreign entity participant in subsection 177A(1)]

1.25 The second circumstance is that a beneficiary of the trust or partner of the partnership has a foreign entity participant during the income year. In working out if this circumstance arises, an entity that has a foreign entity participant as a result of the rule is itself a foreign entity participant when working out if other entities have a foreign entity participant. [Schedule 1, item 1, paragraph (b) of definition of foreign entity participant in subsection 177A(1)]

1.26 For example, if Trust A is a member of Partnership B, which is a member of Trust C, then if Trust A has a foreign entity participant this results in Partnership B and Trust C also having a foreign entity participant.

1.27 It should be noted that a foreign entity participant in a trust or partnership does not need to be the same entity as the foreign entity from which the trust or partnership is not independent - they can be separate entities.

1.28 Effectively, a trust or partnership has a foreign entity participant if some or all of its income could be distributed offshore to an entity that is a non-resident.

1.29 If an entity has both a foreign entity participant and lacks independence there is a real risk that the trust or partnership can be used to transfer income offshore without being subject to the multinational anti-avoidance law.

1.30 These amendments address this risk by ensuring that, for the purposes of satisfying the conditions of the multinational anti-avoidance law, the supplies and income of such a trust or partnership are attributable to the closely related foreign entity. [Schedule 1, item 2, subsection 177DA(8)]

1.31 Even if these amendments result in the supplies and income of a trust or partnership being treated as the supplies and income of a foreign entity under the multinational anti-avoidance law, this does not necessarily mean the general anti-avoidance rules apply. This is because this extension applies only for the purpose of determining if the conditions in subsection 177DA(1) are satisfied. It has no effect on the operation of the taxation law for other purposes, including when determining if a tax benefit arises for the purposes of the other subsections in section 177DA and Part IVA generally.

1.32 It is still necessary to determine that all of the other conditions are met, including (broadly) that an entity has carried out a scheme for the principal purpose of obtaining a tax benefit.

Application and transitional provisions

1.33 The amendments made by Schedule 1 commence on the first day of the first quarter to start following the day this Bill receives Royal Assent. [Clause 2]

1.34 The amendment made by Schedule 1 apply from the original application date of the multinational anti-avoidance law - on or after 1 January 2016 in connection with a scheme, whether or not the scheme was entered into or had begun to be carried out before that day. [Schedule 1, item 3]

1.35 This retrospective application is necessary as the measure is an integrity measure designed to ensure that a key anti-avoidance provision operates as intended.

1.36 Not making the amendment apply retrospectively could reward entities that have engaged in deliberate tax avoidance and incentivise further attempts to undermine the Australian tax system.