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Rural and Regional Affairs and Transport References Committee - 09/05/2012 - Foreign Investment Review Board national interest test

HAMILTON, Mr Stuart, Assistant Deputy Commissioner, Large Business and International, Australian Taxation Office

[18:10]

CHAIR: Welcome. I remind senators that the Senate has resolved that an officer of a department of the Commonwealth or a state shall not be asked to give opinions on matters of policy and shall be given reasonable opportunity to refer questions asked of the officer to superior officers or to a minister. This resolution prevents only questions asking for opinions on matters of policy and does not preclude questions asking for explanations for policies or factual questions about when and how policies were adopted. Officers are also reminded that any claim that it would be contrary to the public interest to answer a question must be made by a minister and shall be accompanied by a statement setting out the basis of the claim.

Mr Hamilton, is there anything further you want to say about the capacity which you appear you today?

Mr Hamilton : My role entails risk strategy, so it is around who we look at and why we look at them.

CHAIR: We are all anonymous here! Can we go to the point which we were at when the tax office was last in. I used the case of an enterprise which is gathering pace, which is a sovereign investor buying sheep farms that produce wool and transferring the wool to a woollen mill which they own and it is not for sale. How do you include them in transfer pricing?

Mr Hamilton : If they were acting as a not for profit they would not necessarily be within the income tax system, but if they are there for a profit-making undertaking and they are claiming expenses and things like that, we can impute a value to the goods that are transferred overseas using our transfer pricing provisions. So we would look for a comparable, work out a value and then impute that back as a turnover.

CHAIR: One of the questions I have put at the previous hearing was if I am double-dumping wool, and we just had this committee very familiar with the reverse of that coming into Australia, which was expensive fertiliser which turned out to be dirt in bags and the poor bugger who ordered it has gone broke. We had God's own trouble getting China to take it back, but eventually they did. How would you be able to put a value on the wool? You would have to know how much wool there was, you have to know the grades or whether it was dags or 3A combing. How you do all that reasonably accurately?

Mr Hamilton : There are four basic methods in transfer pricing. There is the comparable uncontrolled price, so you look at what product is available in the market at arm's length and the price of that and how it varies over time. You can do cost plus, so given the costs that have been incurred, what is a reasonable mark-up for the activity undertaken. You can do resale minus, which is what it was sold at and work back to a cost. Or you can do what is called the transactional net margin method, which is basically a profit split, so you look at the two enterprises involved and you work out, given the expenses, given the personnel, given the functions, assets and risks involved, what would be a fair and reasonable profit split between the two entities.

CHAIR: I think that would be very difficult to work out how much there was for a start. You double-dump wool, you are going to be there—

Mr Hamilton : If we are going down the sheep road, you have got numbers of sheep, you would have an idea. We could ask external experts to come in, and we do.

CHAIR: This would be a nightmare for the tax office.

Mr Hamilton : Our transfer pricing cases tend to take a long time. If you are aware of the SNF case, you would be aware that we are not always successful in raising the issue of comparability.

Senator NASH: Just on that, there is a foreign entity held bit of land that is producing agriculturally, be it crop or sheep or whatever, and the process you have just run through. How do you know they are doing it? What requirement is there for them to let you know? Given that you do not identify foreign entities as a specific subset of the Australian tax payer population, how do you know when they are actually exporting something and whether they are foreign owned entities?

Mr Hamilton : You have got a number of data sources that you can use to triangulate this thing. One, if they are in business, they will often have a registered business name, trade et cetera. Two, they will have bought or sold the property and there may have been capital gains imputed when they purchased the property, so we might be aware of the property. If it is a large undertaking we would generally aware of it; it is hard if you are large to hide.

Senator NASH: Not the entities, specifically the foreign entities. Is that what you are saying, you specifically know if they are foreign held?

Mr Hamilton : The actual business undertaking in Australia, if it is a large undertaking, if they own Victoria sheep station or something like that, it is fairly hard for a large corporation to fly under the radar.. If they want the rights, if you like, the privileges of the corporate veil they will have a company registered in Australia. If they are operating under a permanent establishment or branch they might have some different structure. But either way, if they are a large corporation—and we are talking about large corporations because the mum and dad shops do not really feature—we would generally be aware of it. When they are exporting the stuff they would generally require customs declarations and stuff like that. We have got access to all that information.

CHAIR: It would be possible, wouldn't it, to do without you knowing?

Mr Hamilton : There is no doubt, if people want to sit in the underground economy, it is possible for relatively small undertakings to be undetected.

CHAIR: I want to do it with you in full view of it. I grow wheat and put it in my silo.

Mr Hamilton : If you are undertaking it for a business undertaking—

CHAIR: It is not for sale.

Mr Hamilton : and you are not claiming it on the Australian taxation system?

CHAIR: If I grow wheat on my farm I might get myself into trouble here.

Senator NASH: It would not be the first time.

CHAIR: If you grow wheat and you keep 100 tonne to feed the stock, you put it in the silo and it is not for sale. Are you trying to say in theory the cost of the fertiliser for the 100 tonne I cannot claim a tax deduction on?

Mr Hamilton : It is being used as part of your production setting, it is not private use. So you would claim it.

Senator COLBECK: It is the sale of the cattle rather than the sale of the wheat. I just want to come on the back of that. You have said the interest is if you are claiming input costs or tax deductions. I am just trying to get, I think, to the same place where Senator Heffernan is: what actually triggers your interest? You say that it is hard for a big entity, but if they are not claiming the input costs and taking those benefits, what is to stop an organisation from not claiming the input costs and therefore not raising the attention in respect of the other side of the equation with the sale?

Mr Hamilton : If they have come in and set up for a not-for-profit purpose, so they are not in the business of growing foods, they are not seeking to generate a profit, then they would not be in the taxation system as such.

CHAIR: That is right, if they didn't claim a deduction.

Mr Hamilton : They probably would not be a large corporation.

Senator COLBECK: It comes back to the motivation. I am just trying to understand that. They would probably be in the taxation system if they were employing people, they would have to be.

Mr Hamilton : They would be registered for PAYG, but then that is the same as charities that are not for profits conduct themselves, their turnover does not feature in the taxation system as such.

Senator COLBECK: So, you are talking, for an example, a Sanitarium?

Mr Hamilton : I don't want to name names.

Senator COLBECK: No, I know.

Mr Hamilton : But if somebody is in business not for profit but for a charitable purpose then they would not be lodging an income tax return as such. They would still be in the GST system and the PAYG system—the withholding system—but they would not necessarily be in the income tax system.

CHAIR: But suppose I am a sovereignty. There are these about. Some of them are quite inventive, and there is a lot of largesse; some government officials go off with a bit of largesse from the government, get a guarantee from the government et cetera. I will just do my own little example and then I will transfer it to a government. If I grow wheat and put in my silo and it is not for sale, I do not pay tax on it, do I?

Mr Hamilton : If you are just growing wheat and you are putting in a silo—

CHAIR: It is not for sale; there is no tax.

Mr Hamilton : And you are not claiming any costs, so you are not—

CHAIR: But obviously, if it is one tonne out of 100 tonnes, you are not going to break up the tax; it would become a nightmare. So I have wheat in my silo and it is not for sale, and I eventually feed it to the sheep in a drought or whatever I do with it. If I transfer it to my silo on the other side of Australia to feed the sheep over there and it is not for sale, there is no tax—agreed?

Mr Hamilton : You can explore hypotheticals.

CHAIR: But this does happen.

Senator NASH: It is actually really important.

Mr Hamilton : You have grown wheat and you are claiming costs of your fertiliser, the use of your tractor, diesel and all those things. You then segmented a portion of that off and transferred it across somewhere else for some other purpose. Would we detect it?

CHAIR: No, let me straighten this up for you, because I might be starting to dig a hole here. Suppose I have a farm here and a farm over there, wherever 'over there' is and however much 'over there' it is. If I have a drought over there and I want to transfer some wheat from my drought storage reserve here to over there to feed the stock over there, I do not pay tax.

Mr Hamilton : No, you do not pay tax, because it is entirely within your business unit.

CHAIR: But the freight to get the wheat there is a tax deduction because the purpose is to feed the sheep, and eventually I will feed the sheep and that becomes taxable.

Mr Hamilton : Yes, absolutely.

CHAIR: All right. Suppose I am a sovereign entity which is identical to the entity back home, which is overseas somewhere, and I grow wheat and put it in my silo here, and eventually I transfer it to my silo across a stretch of water, wherever that is—Norfolk Island, Timbuktu or wherever it is—and it is not for sale. Where is the tax?

Mr Hamilton : You have grown the wheat in Australia?

CHAIR: Yes.

Mr Hamilton : You have not claimed any deductions for fertiliser?

CHAIR: I have sold half the wheat onto the market here, for instance.

Mr Hamilton : And you have not sold the other half. Would we be able to impute a value? Yes, we would, under the transfer pricing provisions, because you have conducted a business and presumably you have claimed the expenses to the extent—

CHAIR: But if it were not taxable then I would not have to claim the tax deduction because I would have no tax to pay.

Mr Hamilton : What do you mean by 'it's not taxable'? Look at the words of the act.

CHAIR: If the wheat is in a silo here and it is not for sale, and I transfer it to a silo anywhere else and I am the identical owner of the wheat, why is it taxable?

Mr Hamilton : If it has been transferred—

CHAIR: If it is going across the land—

Senator STERLE: To your other farm.

CHAIR: or a border which happens to be another country on the same continent—

Mr Hamilton : So you have exported it outside Australia?

CHAIR: Yes. It is not for sale, though.

Mr Hamilton : It is not for sale. Have you claimed expenses against the whole of the production or just against part of the production? If you have only claimed expenses against part of the production then we do not have a problem.

Senator FAWCETT: The end point that the chair is probably coming to is that if country X has a sovereign holding in Australia, grows wheat—and let us assume they do not claim anything; they just self-fund the whole operation and they grow however many tonnes of wheat—

Mr Hamilton : And they export it. Would they be taxable? No.

CHAIR: That is the answer.

Senator NASH: So that is the answer. I am just checking it. So there is no tax payable if they do not claim anything and then they export the grain.

Mr Hamilton : If they are not there to make a profit then they would not be in the income tax system, because they are not earning income.

Senator NASH: That took a while, but we got there.

CHAIR: Wow!

Senator NASH: 'Wow' is right. 'Wow' is seriously right.

Senator EDWARDS: This is a big problem.

Senator STERLE: So this could have happened for the last 30 or 40 years.

CHAIR: This is like Mick Keelty, who was the AFP commissioner. He alerted me to the risks of the changing concept of sovereignty because of sovereign foreign investment and all the things around that, including human displacement. This is sort of getting to the point where it confirms that.

Senator FAWCETT: Having clarified that, obviously, the concern that the chair has been expressing is the situation whereby a substantial amount of Australia's land is purchased by a sovereign entity who then ships it out such that it distorts our market because that grain—to take grain as an example—is not in our market. We get no return from the land because there is no taxation on it, and so that obviously then goes to our food security et cetera. That is the concern that is being expressed.

Hence my question earlier—I do not know if you heard it—about the alternative ways of obtaining income by having shorter-term leases so you have certainty for an entity. But the question for you from the Tax Office perspective is, are there any precedents where a body is essentially identified for taxation and because of an unusual circumstance it is outside the normal parameters? Has there ever been that, or would that be a complete departure from the way we have run taxation in this country?

Mr Hamilton : One of the factors that we use in our case selection activities is to look at those entities that are in the taxation system and that have lower results than one would expect when comparing them to their peers or their past. So, sudden drop-offs in tax performance are looked at.

We have not always successfully challenged those, and if you look at the SNF case you can see a company that made losses for 10 years but which was able to come up with a comparable that the court accepted. I believe the law is being reviewed in that area. But there are other ways of lowering your tax in Australia, particularly for foreign-owned corporations.

Senator NASH: Sorry—what did you say?

Mr Hamilton : There is a variety of mechanisms, without resorting to transfer pricing, that foreign-owned entities can utilise to lower their taxation in Australia.

Senator NASH: Could you take that on notice and just provide to the committee what they are?

Mr Hamilton : Debt. That is the simple one. If you are investing into Australia you have the choice between putting in a dollar of equity or a dollar of debt. To the extent that you are not borrowing overseas to fund it, if you put it in as a dollar of debt up until the cap ratio of three to one, you obtain an interested deduction for that. The interest withholding tax is 10 per cent as against the company tax rate of 30 per cent. There is a 20 per cent tax shield on that. Why would we be surprised that foreign owned corporations, on average, pay less tax than Australian corporations? It is built into the system.

CHAIR: Could I just go back to the example I used earlier? We have come across a company—and some of these are quite colourful, shall I say, in their entities—where a provincial government, shall I say, has lent a facility to a person, who may or may not have been a government official. Part of the financing arrangement is a 30-year interest-free loan, and the end result is that in 30 years time the asset reverts to the provincial government—there are all sorts of commercial arrangements like that. When the asset reverts to the government, how would you treat that for capital gains tax purposes? Would you like to take that on notice?

Mr Hamilton : I would prefer to take these kinds of specific questions on notice so I can provide a meaningful answer.

CHAIR: Do that. We absolutely want to get this right.

Senator COLBECK: I think you have dealt with what I was looking for. I am trying to deal with this transfer process. Is there a specific registration process required? You have talked about ABN and, obviously, registration processes.

Mr Hamilton : Export licences.

Senator COLBECK: There is a whole range of ways that someone would come up on your radar?

Mr Hamilton : Yes, particularly if they are a large entity.

Senator COLBECK: What I am really trying to explore is the reality or the practicality of conducting business in the way we have just been talking about. So the purpose of the business is not to make a profit; the purpose of the business is to produce and transfer a commodity—but not for a profit?

Mr Hamilton : Yes.

Senator COLBECK: So the motivation that underlies it is that purpose—and, obviously, we are talking about food. Is there a capacity within the system to deem that that is the conduct of a business, even though it is within a business? This is probably a little bit outside your range, but is there anything in our company structures process that requires a registration that might provide a differentiation of the entity that actually triggers the transfer process? Do you know what I am saying?

Mr Hamilton : I am not sure I quite understand the last part of the question.

Senator COLBECK: Can a sovereign entity from a particular country fully register as an entity in this country under exactly the same provisions, the same structure, without any differential in what it is? So you are talking about within the entity, effectively, completely.

Mr Hamilton : Yes. So it could operate as a branch or a permanent establishment in Australia, as Australian banks often do in foreign jurisdictions.

Senator COLBECK: So it is effectively the one entity.

Mr Hamilton : One entity.

Senator COLBECK: So, with regard to the discussion that Senator Heffernan had about a farm in New South Wales and a farm in Western Australia, if they are in the same business structure, it is for all intents and purposes the one farm?

Mr Hamilton : Yes, it is just the one business. I might need to clarify this. If you have company X in the United States, China, the UK or wherever it is and it operates a business in Australia, particularly if it is a landholding, that would be deemed to be a permanent establishment in Australia, and the business profits associated with that would be taxable in Australia. Australia would have taxing rights.

Senator COLBECK: Yes, but only if they were operating for the purpose of making a profit?

Mr Hamilton : If they were not a charity, yes.

Senator COLBECK: If they were not a charity?

Mr Hamilton : Yes. I do not want to go too far into it. If, for example, they were growing the food entirely for charitable purposes—as in to feed the hungry masses—then that would not be taxable. If they were selling the produce in another country, that would be a different question.

Senator COLBECK: Okay. So that does actually trigger the provision?

Mr Hamilton : Yes. They would be in business.

Senator COLBECK: They are in business. That part of the business is occurring here in Australia. Whether or not they claim tax on their inputs and therefore try to avoid tax on their outputs is a completely different matter. The fact is that they are carrying on a business in that other country so they are deemed to be in business.

Mr Hamilton : Yes. The other thing to consider is that, in our double-taxation agreements, we have information exchange articles with the other country's tax administration, which we utilise. If we were aware of a concern that involved another country, we would contact the other country's tax administration and ask their competent authority to investigate on our behalf.

Senator COLBECK: So, if Bill moved from New South Wales to Western Australia and he sold a bit of it over there, that would get picked up through that broader process?

Mr Hamilton : Yes, because that is entirely within Australia.

Senator COLBECK: It is entirely within Australia. Okay. So, if they are carrying on a business in the other country, and the product of what they are doing in Australia is an input into that business, they are carrying on a business and are therefore subject to tax and subject to the deeming provisions within the tax laws.

CHAIR: By the way, the Foreign Investment Review Board sat there and said that, if I were a sovereign entity, there is mandatory reporting under what they require. I said to them, 'What happens if they don't comply—if I they are a sovereign identity but don't own up?' They said, 'We have a compliance regime' I said, 'What is the compliance regime?' They said, 'We've been to Sydney and instructed some lawyers down there.' This is in real time; this is only a couple of months ago. This has been going on for years, mind you, but they have just now been to Sydney and talked to some lawyers and they are going to go to Melbourne to talk to some lawyers. They said, 'We have a phone line you can ring in on if you want to tell us about it, and we don't have a penalty if they don't report and we don't cancel the sale.' It is a pretty tough compliance regime, isn't it!

Anyhow, that is the evidence we received. My difficulty is that they are a sovereign entity and we are being dopey enough to allow them. Mr McGeachy from the Reserve Bank said to this committee down in the old parliament the day Obama was here that it would not matter if another country came and bought, I think, 30 per cent of Australia's productive capacity in agriculture. But I think that it would.

How do you absolutely tell another nation, who has to meet their global food task, 50 per cent of that? This is not looking at next year's election or the one after; this is 'Where are we going to be in 50 years time?' We know that the world, barring a human catastrophe, is going to have approximately 12 billion people by 2070 with 1.8 billion to two billion in China—and they may have lost the use of the great northern plain by then, by the way. They will have to feed half the population somewhere else, so they say, 'We'll go to Australia, we'll go to Africa—we'll go all over the place—and we have bought 30 per cent of the productive capacity of an area to feed the population.' How do you impose your sovereign rules on their sovereignty over there? It is a bit like telling the Indonesians how to kill their cattle; it is a bit difficult if it is not within your remit. How do we do that?

Mr Hamilton : So you are talking from a tax administration angle here?

CHAIR: Yes.

Mr Hamilton : I will keep the question in relation to tax administration. The tax office has, I would say, a very well-developed compliance program and approach, and if a business—

CHAIR: Which would impose itself on a communist government?

Mr Hamilton : If that—

CHAIR: We are not talking about an auntie of the government but about the government itself. Best of luck!

Mr Hamilton : If they are operating in Australia as a business—

CHAIR: As a government in business here.

Mr Hamilton : If they are operating in Australia for business, then the entity that they are operating under would be looked at the same as any other business entity in Australia, and, if it was not returning the appropriate amount of profit, it would be investigated and the appropriate compliance action would be undertaken.

CHAIR: Yes, but if the enterprise that is operating here is the sovereign entity and is producing something for a national interest task back home, not for a profit—

Mr Hamilton : So we are back in the charity space, are we—the not-for-profit space?

CHAIR: I do not know whether you call a government who wants to feed the starving masses, as you put it, a charity.

Mr Hamilton : I know of no instances of the arrangement that you are talking about.

Senator NASH: But could a foreign entity in those circumstances register as not-for-profit organisation?

Mr Hamilton : I know of no instances of this kind of arrangement.

CHAIR: It is a bit out of your remit—fair enough.

Senator NASH: Okay, we will ask the appropriate people. Earlier on we were talking about the foreign-owned entities that come under your radar. You said that the large ones technically do not fall under the radar because of x, y, z. What is your definition of large? How do you measure it?

Mr Hamilton : Large businesses for our purposes are those with a turnover greater than $250 million—so they are large.

Senator NASH: How many agricultural entities have a turnover of more than $250 million?

Mr Hamilton : Not many.

Senator NASH: Could you take it on notice to come back with a figure that is close as you can get to how many? So virtually all of the agricultural entities that are foreign owned do not come under the radar; they will fall outside what you are talking about because they will be classed as small?

Mr Hamilton : Most would be small, but, if you look at tax stats, the data that we have is that there are 83 non-resident entities, 65 of which are private companies, four of which are public and 14 of which are 'other'—joint ventures et cetera—as against resident companies of which there are 16,337 private companies, mainly ma-and-pa farms, and then there are 133 public companies, 82 co-ops, seven nonprofits and 33 'other'. So foreign owners are a small percentage.

Senator NASH: For the purposes of us trying to get a handle on the relationship between foreign entities operating here, in terms of purchasing and working agricultural land and where that comes under the ATO's radar, it is pretty much luck of some sort, is it not? I will just expand on that.

Thank you for your answer to the question on notice. We are trying to get a sense of how many foreign entities are currently being taxed by the ATO. You said you do not identify foreign entities as a specific subset. You can identify some if the taxpayers use a primary production business code, self-assessors, nonresidents or identify but their beneficial owners are offshore, but, as you say, all of those are self-selected. So there is no real requirement, is there, for a foreign entity to comply with providing the ATO with the details? It just falls through the system if they are claiming X, Y, Z. Have I got that right?

Mr Hamilton : I would probably caution two things in relation to data. The first thing is that it is based on self-assessed answers to questions about primary production and non-resident status. My experience is that the non-liability determination labels—the statistical labels, such as nonresident/resident—are generally more prone to error than those used to compute tax liabilities. I do know that, with the ANZSIC codes for large entities where we believe them to be in error, for tax stats purposes we correct those.

The second point I would make in relation to the data you have been given is that the answers are a bit like comparing apples and oranges. Domestic primary production companies tend to be relatively small, as I mentioned. There are 16,000 of those.

Senator NASH: Yes, and there is the accumulation issue we have been talking about.

Mr Hamilton : Foreign primary production companies investing from an overseas jurisdiction will naturally tend to be larger, and the data that we have confirms that. But to draw accurate conclusions about the tax performance of foreign entities versus domestic entities you really need to construct peer samples and observe them over time, and we have not done that.

Senator NASH: I have a couple of last questions, and I might put some on notice if that is all right. Is the $250 million for the large, for example, property by property? If you have got one entity that is—

Mr Hamilton : It is the corporate group.

Senator NASH: It is the corporate group. So, if they owned six or seven properties and that whole amount adds up to $250 million, it will come under your radar?

Mr Hamilton : They end up in my patch, but for entities smaller than that you have got the small and medium market and the micro market. We go down to quite small turnover.

Senator NASH: Finally, are there any distinctive tax breaks or incentives in place to encourage foreign investment in Australia specifically?

Mr Hamilton : I would have to take that on notice. There are a range of concessions given, but most of them are given to domestics as well, in relation to primary production.

Senator NASH: If you could give us some detail around that as well, that would be useful.

CHAIR: Finally, there is an argument, which I have described in colourful language, about what the threshold ought to be for reporting. My view is that if it hits the threshold, there are no pointers to where the threshold is and nothing happens. You have the ABN status. You could possibly pick up, through the tax office, every business transaction of an ABN registered company, and I presume that would flow on to sales and for capital gains tax purposes et cetera. When a corporation or a sovereign entity comes into Australia and it is the exact entity of a sovereign entity like the government of Kuwait or something, do they establish themselves here with an ABN? Does the government get an ABN?

Mr Hamilton : I would have to take that on notice.

CHAIR: Thank you. I just put on record that all these names on the table are not our real names—we are all scared of the tax office! Thank you very much for your evidence. We look forward to some answers. Obviously this is pretty complex.