PE Avoidance Integrity Measures

Australia proposes new rules to counter fragmentation of activities to avoid permanent establishment.

2015-06-09

Australia has released exposure draft legislation which introduces new measures designed to counter multinational groups using “artificial or contrived” arrangements to avoid triggering a taxable presence or permanent establishment (PE) in Australia.

The OECD base erosion and profit shifting (“BEPS”) project being run through the G20 is currently considering this very issue. In particular, the deliverables from action item 1 “Digital Economy”, action item 5 “Harmful Tax Practices”, action item 6 “Preventing Tax Treaty Abuse” and action item 7 “Avoidance of PE Status” may mitigate this tax risk.

Implementing rules based on the OECD final recommendations would assist in removing uncertainties in international business. For this reason, a multilateral approach is the preferred method as countries taking unilateral action unfortunately will introduce greater tax uncertainly and compliance costs.  

It is hoped that Australia’s legislation will be aligned as closely as possible to the OECD recommendations in the future.

Who will be impacted by the proposed rules?

Large multinational groups with significant activities in Australia who ultimately return a substantial part of their profits from their Australian sales to a low or no tax jurisdiction could be caught by the proposed law.

Specifically targeted is the fragmentation of activities by multinational groups with the purpose of avoiding the triggering of a taxable presence in Australia. The menace that is the source of frustration for taxation authorities is the “double non-taxation” as described by Pascal Saint-Amans, Director of the OECD's Centre for Tax Policy and Administration; the profits not being taxed in Australia and the country/countries in which the bulk of the profits are recognised. In other words, the tax treaties are designed to avoid double taxation and not to be exploited to achieve double non-taxation.

Why are these changes important?

The structures implemented by multinational groups are varied. These include the use of commission agents, marketing entities, resellers, sales agents and service entities. These entities may be either part of, or commercially independent from the multinational group.

The new proposed rules mean that multinational groups’ structures may need to be reviewed to assess the likelihood of triggering the proposed integrity measures. At the very least, the commercial reasons for the use of particular structures should be well documented. In particular, the burden of proof rests with the taxpayers in establishing whether they fall outside the rules.

In instances where the proposed rules are triggered, the Commissioner of taxation can cancel any tax benefits (including imposing any withholding taxes avoided) obtained by the taxpayer.

When do the rules apply?

The proposed measures are in relation to tax benefits that a taxpayer obtains on or after 1 January 2016, irrespective of when the arrangements were put in place.

What are the proposed changes?

The Government proposes to amend Australia’s anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 to counter PE avoidance schemes.

The new measures apply where the following are met:

  • A non-resident sells goods and services (including digital supplies) to unrelated Australian customers
  • The income is not taxed in Australia because the non-resident does not have a taxable presence or PE in Australia
  • An entity paying tax in Australia (typically an Australian subsidiary in the group) who is associated or commercially dependent on the non-resident, undertakes activities in Australia in support of the supply made by the non-resident. The activities undertaken in Australia are typically sales, marketing, lead generation, implementation and service/support type activities
  • It is reasonable to conclude that the division of activities between the entities in the group are designed to avoid triggering of a PE by the non-resident in Australia. Further, the group did this for a principal purpose (needing not be the sole or dominant purpose) of obtaining a tax benefit. The tax benefit would encompass paying less tax in Australia, avoiding Australian withholding taxes or even reducing liability to foreign taxes. The last item is to negate the argument that the structure has been put in place for the principle purpose of reducing overseas tax rather than Australian tax
  • Activities carried out by any group members giving rise to income in a low tax or no tax jurisdiction including income that is preferentially taxed in a jurisdiction (whether or not it is a low or no tax jurisdiction). However, the proposed changes will not apply if:
    • The entity conducting the activity undertakes substantial economic activity in the (low or no tax) jurisdiction
    • The activity is not related directly or indirectly to the Australian income.

Furthermore, the rules will not apply unless the multinational group has annual global consolidated turnover exceeding $1 billion in Australian dollar terms. This is to be tested annually.

What are the potential impacts?

Where the rules are triggered, the Commissioner has the power to look through the scheme. However, this will require the Commissioner to formulate an alternate postulate. This will be fraught with complexity and uncertainties. 

It will be extremely contentious as to whether arrangements adopted by multinationals are for the principle purpose of securing a tax benefit. For example, the use of commission agents to undertake “significant sales activities” could potentially be caught by the proposed measures. However, the use of commission agents is often a more cost effective and administratively efficient model relative to other models (such as a fully fledge distributor or reseller model). In particular, the use of a commission agent structure enables the centralisation of inventory and certain functions such as financing, debt recovery, logistics and foreign currency management and hedging.

The upshot is that the structure delivers valuable business efficiencies to the group. Furthermore, the fact that a commission agent is a member of the multinational group should not by itself be regarded as mischievous. This arrangement has its own merits including enabling the group to secure resources with the right skills and calibre focusing on the group’s products. In addition, company secrets and intellectual property are better protected.

Some questions that remain unanswered include:

  • How would the profit be attributed to Australia? Multinational groups have various alternative structures and models available to it. Each structure has its advantages and disadvantages. It is not necessary that the alternative model is always the non-resident selling products directly to the Australian customers. The use of a reseller or distributor or an independent commission agent are all equally credible and valid structuring propositions. 
  • How are profits attributed to long term contracts where the initial sales activities becomes less significant compared to the total activities performed over the life of the contract? This is particularly important if activities are performed outside Australia.
  • Given the unilateral approach adopted, will there be agreement amongst affected jurisdictions in relation to the attribution of profits to Australia? The likelihood of consensus would more likely be achieved if a multilateral approach is adopted.
  • What is considered substantial economic activity and in particular in the context of maintaining and protecting the intellectual property of the group?
  • What is a low corporate tax rate? Hong Kong and Singapore are commonly used as the Asian hub of multinational groups. Are the corporate tax rates of these jurisdictions considered low?

Australia is also proposing to introduce GST on intangible supplies to Australian consumers, which will affect multinationals making digital supplies (including software and movie and music streaming).  

If you have any queries in relation to this article, please contact Daren Yeoh or your ShineWing Australia relationship partner.