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Australian Taxation Office issues Taxpayer Alert on treaty shopping arrangements to obtain reduced withholding tax rates — Orbitax Tax News & Alerts

  • The Taxpayer Alert provides examples of treaty shopping arrangements that the ATO views as higher-risk arrangements which will warrant increased scrutiny by the ATO.

  • The TA is intended to enable informed decisions by taxpayers, prevent further spread of higher risk arrangements and to demonstrate risk detection ability.

  • The ATO recommends that in light of TA 2022/2, taxpayers should review their arrangements to identify transactions which may produce similar treaty benefits (i.e., reduced WHT) under Australia’s DTAs with other treaty countries, whether as a result of a restructure or acquisition.

Executive summary

On 20 July 2022, the Australian Taxation Office (ATO) issued Taxpayer Alert (TA) 2022/2: Treaty shopping arrangements to obtain reduced withholding tax rates. The TA provides examples of treaty shopping arrangements that the ATO views as higher-risk arrangements which will warrant increased scrutiny by the ATO. The ATO uses TAs as an early warning to the community about a new or emerging activity or arrangement that is causing the ATO concern. The TA is intended to enable informed decisions by taxpayers, prevent further spread of higher risk arrangements and to demonstrate risk detection ability. Where the ATO is considering the application of specific or general anti-avoidance provisions, this can trigger the release of a TA.

The TA is directed at arrangements that seek to obtain a treaty benefit through interposition of one or more related entities between an Australian resident entity and the ultimate recipient of the royalty or dividend payment. Typically, the interposed entity is a resident of a treaty partner jurisdiction and the ultimate recipient is located in a jurisdiction that either does not have a double tax agreement (DTA) with Australia or if it is an existing treaty partner of Australia, the treaty benefit obtained under the DTA is less favorable for tax purposes. 

The operation of the Australian anti-avoidance provisions which the ATO says it might invoke, center around purpose, so for taxpayers with interposed holding companies within their group it will be important to maintain contemporaneous documentation and other objective evidence supporting the rationale for the use of a particular jurisdiction. 

Detailed discussion

Examples of higher-risk arrangements

The ATO provides two examples of higher-risk arrangements which are covered below.

Example 1 – Entity interposed to reduce Australian royalty withholding tax (WHT)

The first example presents a scenario comparing a hypothetical group structure prior to a restructure and after a restructure.

Prior to the restructure, the example focuses on two countries, Australia and Treaty Country A, which have an existing DTA (AUS – A DTA). The Australian company (Aus Co) is a member of the Foreign Company (For Co) Group, with For Co being the ultimate parent company. Assume that:

  • Aus Co has an exclusive license agreement with For Co which grants Aus Co the right to use various intellectual property (IP) for its business activities in Australia
  • Under the agreement, Aus Co is required to pay a license fee to For Co and this constitutes a “royalty” under the relevant treaty article
  • Aus Co’s royalty payments to For Co are subject to royalty WHT at a reduced rate of 10% under the AUS – A DTA

However, after the restructure, the exclusive licensing arrangement with Aus Co is terminated and instead, another subsidiary of For Co, Treaty Co (who is a tax resident in Treaty Country B) is granted the rights to sub-license the IP in Australia. Aus Co enters into a new exclusive licensing arrangement with Treaty Co and Aus Co pays royalties to Treaty Co which are, in turn, paid by Treaty Co to For Co.

The effect of the restructure is that Treaty Co applies a reduced royalty WHT rate of 5% under Australia’s DTA with Treaty Country B (AUS-B DTA) in respect of the royalty paid by Aus Co to Treaty Co.

Example 2 – Acquisition structured through a treaty jurisdiction to reduce Australian dividend WHT

The second example focuses on a company, Non-treaty Co, which is a conglomerate that invests in global infrastructure, including in Treaty Country. Non-treaty Co is based in a jurisdiction that does not have a DTA with Australia. Treaty Country has an existing DTA with Australia.

Non-treaty Co subsequently acquires Aus Group. However, prior to the acquisition of Aus Group, Treaty Co, Aus Co and Aus BidCo are incorporated. The resulting structure sees Treaty Co (a nonresident for Australian tax purposes based in Treaty Country) become the holding company of Aus Co which sits within an Australian tax consolidated group, comprised of Aus Co at the top, followed by Aus BidCo and then Aus Group. By virtue of the transaction, Non-treaty Co indirectly, via Treaty Co, holds 100% of the interests in Aus Group.

The effect of the acquisition is that Treaty Co applies a reduced dividend WHT rate under Australia’s DTA with Treaty Co in relation to unfranked dividends paid by Aus Co to Treaty Co compared to if the dividends had been paid directly to Non-Treaty Co.

Implications

The ATO recommends that in light of TA 2022/2, taxpayers should review their arrangements to identify transactions which may produce similar treaty benefits (i.e., reduced WHT) under Australia’s DTAs with other treaty countries, whether as a result of a restructure or acquisition. The TA notes that taxpayers will often purport to have commercial justification for undertaking particular transactions in a particular way (e.g., commercial benefits and/or synergies flowing to Australian operations or an interposed entity). However, it is paramount that taxpayers maintain contemporaneous documentation and other objective evidence to substantiate their reasons for structuring a transaction in a particular manner. 

This will assist taxpayers to address the ATO’s concern that reducing WHT rates was one of the principal or main reasons for a transaction and/or arrangement. In the absence of such documentation or objective evidence, the transaction/arrangement will more likely attract the operation of anti-avoidance rules in Australia’s DTAs or domestic anti-avoidance legislation. 

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For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Sydney

  • Alf Capito, Tax Policy | alf.capito@au.ey.com
  • Sean Monahan, International Tax and Transaction Services | sean.monahan@au.ey.com
  • Tony Cooper, International Tax and Transaction Services | tony.cooper@au.ey.com

Ernst & Young (Australia), Perth

  • Andrew Nelson, International Tax and Transaction Services | andrew.nelson@au.ey.com

Ernst & Young (Australia), Melbourne

  • Tony Merlo, Tax Policy | tony.merlo@au.ey.com
  • Graeme Friend, International Tax and Transaction Services | graeme.friend@au.ey.com

Ernst & Young LLP (United States), Australia Tax Desk, New York

  • David Burns | david.burns1@ey.com

Ernst & Young LLP (United Kingdom), Australia Tax Desk, London

  • Naomi Ross | naomi.ross@uk.ey.com