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ATO Issues Guidance on Key Compliance Risks for Large Corporate Groups — Orbitax Tax News & Alerts

The Australian taxation Office (ATO) has issued new guidance on Key compliance risks for large corporate groups, dated 22 January 2021. The guidance covers international and domestic risks, along with examples and links to further guidance. Different issues of particular concern are presented as follows:

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International risks

Profit shifting

Increased globalisation has brought many benefits, including increased economic growth for countries. But it has also brought them new challenges – as a result of the increasing share of global gross domestic product and trade attributable to multinational enterprises.

Companies no longer need to locate their operations close to customers or have fully integrated operations in a single location. Instead there is increasing centralisation of functions regionally or globally, with supply chains dispersed across countries. The rise of the information and service economies, as well as advances in technology, have helped multinational enterprises to be able to place staff and operations in locations geographically distant from their customers. Some nations may also seek to attract investment by multinational enterprises by offering attractive tax rates and other incentives.

These factors have also allowed for tax planning that takes advantage of arbitrage opportunities to minimise global tax payments. For some multinational enterprises, this tax planning goes beyond acceptable bounds. That's why we have an increasingly strong focus on global profit shifting.

Related party debt

A key corporate tax avoidance tactic is the excessive allocation of debt into Australian companies. This is sometimes described as debt dumping. The transfer pricing, thin capitalisation and general anti-avoidance rules may apply to these schemes.

We're currently focusing on the more prevalent forms of related party debt risks. We have:

  • warned taxpayers and their advisers of high-risk arrangements through our taxpayer alerts
  • provided guidance to assist taxpayers self-assess the tax risk of their related party financing arrangement and our likely compliance approach given that risk profile
  • undertaken litigation in the most serious cases.

An additional schedule to our practical compliance guideline (PCG) on related party financing arrangements, covering derivative arrangements, was finalised in November 2019. The draft of another, outlining factors for determining if an interest-free loan is debt or equity in identifying the arm’s length conditions, was published in August 2020.

We've also published a:

  • tax determination to assist taxpayers comply with the thin capitalisation rules on costs that are debt deductions for thin capitalisation purposes
  • tax determination on valuation of debt capital
  • taxation ruling on the application of the arm’s length debt test
  • PCG outlining our compliance approach to taxpayers who use the arm's length debt test.

Offshore service hubs

Some multinational enterprises are using centralised operating models, often referred to as hubs, to undertake various activities. These arrangements are usually based on commercial considerations but sometimes the tax treatment may not be appropriate.

We've issued a practical compliance guideline to assist taxpayers to manage the risks and costs associated with hubs. Two schedules in the PCG cover marketing and procurement hubs.

Inbound supply chains

Appropriate profit being recognised in Australia

Many multinational businesses operate their Australian operations through subsidiaries. They use these to buy goods or services from their offshore parent or related companies, and on-sell to Australians.

The key tax question is whether the price paid for those goods or services is an appropriate price under the law. Determining this can be particularly difficult when the goods or services have unique features. This can be hard even for taxpayers trying to do the right thing.

Looking at the entire supply chain through a variety of lenses helps to determine if the pricing is giving sensible or distorted results. It can help clarify if the appropriate profit is being recognised in Australia.

In March 2019, we published a PCG on transfer pricing issues related to inbound distribution arrangements, outlining our compliance approach. The PCG includes industry-specific schedules to provide more detailed guidance.

Intangible assets and non-arm's length arrangements

Intangible assets, including but not limited to intellectual property, are highly mobile assets. There are significant incentives to locate intangible assets in jurisdictions with favourable tax regimes.

Tax benefits may be inappropriately obtained via the dynamic migration or artificial allocation of intangible assets, and rights in those assets, to offshore related parties. The risk is present due to non-arm’s length arrangements that:

  • migrate or artificially allocate Australian generated intangibles to offshore related parties
  • involve the use of intangible assets, particularly where the value of these assets is derived from or maintained by the activities of Australian entities
  • dispose of or allocate Australian generated intangible assets to offshore related parties and subsequently grant rights in these assets back to Australian entities.

Intangible assets, particularly ‘hard to value’ intangibles, may have special or unique characteristics that complicate the search for comparable transactions and make market prices difficult to determine at the time of the transaction. OECD public guidance – in particular, BEPS Action 8: Implementation guidance on hard-to-value intangibles – should be considered.

We've also issued two taxpayer alert advising taxpayers and their advisers to our concerns with arrangements involving intangible assets.

Outbound permanent establishments

We're focusing on Australian income tax consolidated groups with certain outbound permanent establishment arrangements. These arrangements are structured to ignore intra-group transactions for Australian income tax purposes. Yet they're recognised by the offshore tax regime. We're concerned these arrangements may result in the under-reporting of income in Australia, incorrect deductions claimed here, and the double non-taxation of income.

These types of arrangements are also covered by a specific subdivision of the hybrid mismatch rules. The new rules are specifically designed to counteract the effects of hybrid mismatches and ensure multinational groups don't gain unfair tax advantages over domestic groups.

We'll work with impacted taxpayers with their transition to compliant arrangements.

Foreign resident disposal of Australian property

We're concerned about foreign residents who obtain a tax benefit or avoid Australian tax obligations when they dispose of Australian property. We want to ensure asset classifications and valuations are consistent with legal requirements. For example, profits made from the sale of Australian real property (and related assets) should be taxed in Australia. Some schemes seek to shift or attribute value to non-land assets to escape taxation.

Domestic risks

Re-characterisation of income from trading enterprises

We're concerned with arrangements that seek to divert and re-characterise business trading income into concessionally-taxed passive income flows. This may involve a single business being divided into separate enterprises. We've issued a taxpayer alert about our concerns.

Legislative amendments have addressed some of these concerns by:

  • applying a 30% withholding tax on trading income converted to passive income via a stapled structure or distributed by a trading trust, and income from agricultural land and residential housing
  • amending the thin capitalisation rules to prevent foreign investors using double gearing structures to convert active business income to more favourably taxed interest income
  • limiting existing tax exemptions for foreign pension funds and sovereign wealth funds to passive income and portfolio investments only.

The legislative amendments don't cover all of the arrangements we outlined in our taxpayer alert. We continue to look closely at these other types of arrangements and will take compliance action where we consider an arrangement poses a compliance risk. We're also reviewing transitional election forms to ensure taxpayers electing to obtain transitional relief are entitled to that relief and complying with the legislation.

Research and development

The research and development (R&D) tax incentive program is administered jointly between AusIndustry and the ATO. As part of the co-administration, we've developed a joint risk strategy to cover particular activities of concern. These include claims attributing business-as-usual nature expenses to eligible R&D activities, and claiming R&D incentives for software development.

We focus on incorrect claims in the building and construction, agriculture and mining industries. The strategy also highlights some R&D consultants as potential contributors to the risk.

We've issued a number of taxpayer alerts, jointly with AusIndustry, outlining concerns with specific arrangements.

Property and construction activities of large private groups

Property and construction is a significant industry in the Australian economy. There has been strong growth in some property markets. Despite this, we've seen low tax performance and higher tax debts and insolvency rates than other industry segments. This has led us to take an industry-wide approach to risks in the segment for large private groups.

Group structuring and business events

Significant business events attract our attention. These may be mergers and acquisitions, divestments of major assets and demergers, capital raisings and returns of capital. The structure of groups and changes that occur in those structures can present significant tax issues.