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Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 [and] Diverted Profits Tax Bill 2017



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ISSN 1328-8091

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BILLS DIGEST NO. 81, 2016-17 27 MARCH 2017

Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 [and] Diverted Profits Tax Bill 2017 Jaan Murphy Law and Bills Digest Section

Contents Purpose of the Bill ............................................................... 3

Why two Bills? ......................................................................... 3

Structure of the Bills ............................................................ 3

Background ......................................................................... 3

Terminology used in this Digest .............................................. 3

Background to the Bills ............................................................ 4

2016-17 Budget ....................................................................... 4

Consultation paper, exposure draft and limited release confidential exposure draft ..................................................... 4

Committee consideration .................................................... 5

Senate Economics Legislation Committee............................... 5

Senate Standing Committee for the Scrutiny of Bills .............. 5

Policy position of non-government parties/independents ..... 6

Opposition ............................................................................... 6

The Australian Greens ........................................................... 6

Other non-government Members and Senators ................... 6

Position of major interest groups ......................................... 6

The DPT as unilateral action to combat tax evasion ............... 6

‘Chilling’ effect on investment ................................................. 7

Breadth of application ............................................................. 8

Interaction with tax treaty obligations .................................... 8

Interaction with other tax laws ............................................... 9

Financial implications ........................................................ 10

Statement of Compatibility with Human Rights .................. 10

Parliamentary Joint Committee on Human Rights ................ 10

Key issues and provisions................................................... 10

Date introduced: 9 February 2017

House: House of Representatives

Portfolio: Treasury

Commencement Schedule 1 (except item 7), Schedule 2 and Schedule 3 of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 will commence on the first 1 January, 1 April, 1 July or 1 October after Royal Assent. The commencement of item 7 of Schedule 1 is contingent on the Treasury Laws Amendment (Enterprise Tax Plan) Act Bill 2016 being passed by Parliament. The Diverted Profits Tax Bill 2017 will commence at the same time as item 13 of Schedule 1 of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017.

Links: The links to the Bills, Explanatory Memoranda and second reading speeches can be found on the Bill’s homepages for the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and the Diverted Profits Tax Bill 2017, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the Federal Register of Legislation website.

All hyperlinks in this Bills Digest are correct as at

March 2017.

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Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 .................................................... 10

Schedule 1 ........................................................................ 10

Objects of the DPT ................................................................. 10

Entities captured by the DPT ................................................. 10

Definition of significant global entity captures Australian entities ................................................................................... 11

Entities specifically excluded from DPT ................................. 11

Conduct captured by the DPT................................................ 11

Scheme generally ................................................................ 12

Tax benefit ........................................................................... 12

Principal purpose test ............................................................ 13

Concerns about the use of the principal purpose test ........ 13

Support and rationale for the use of the principal purpose test ........................................................................ 14

Factors to be considered when applying the principle purpose test........................................................................... 15

Existing matters to be considered ....................................... 15

Quantifiable non-tax financial benefits ............................... 15

The amount of the tax benefit ............................................ 16

Modifications where thin capitalisation provisions apply ..... 17

Modifications where controlled foreign company provisions apply ..................................................................... 17

Schemes excluded from the DPT ........................................... 18

The $25 million income test ................................................ 18

The sufficient foreign tax test ............................................. 18

The sufficient economic substance test .............................. 20

Amount of DPT ...................................................................... 21

How DPT is calculated ........................................................... 22

DPT Rate ................................................................................ 22

Criticisms of the DPT rate and calculation methods ........... 22

Assessment and administration ............................................ 23

The Commissioner can issue a DPT assessment within seven years of an income tax assessment .......................... 24

Upfront payment of DPT ..................................................... 24

‘Pay first, dispute later’ ....................................................... 24

Restrictions on taxpayers providing evidence to the court in a dispute................................................................. 25

Key issues and provisions—Schedule 2 ............................... 26

Key issues and provisions—Schedule 3 ............................... 28

Criticisms of the transfer pricing guidelines .......................... 29

Concluding comments ....................................................... 29

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Purpose of the Bill The purpose of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (the Main Bill) is to amend the Income Tax Assessment Act 1936, (the ITAA 1936), Income Tax Assessment Act 1997 (ITAA 1997), Taxation Administration Act 1953(TAA 1953) and other legislation to:

• introduce mechanisms for assessing the diverted profits tax (DPT)

• increase penalties for ‘significant global entities’ that breach their tax reporting obligations and

• amend Australia’s transfer pricing rules to give effect to the Organisation for Economic Co-operation and Development’s (OECD) recommendations.1

The purpose of the Diverted Profits Tax Bill 2017 (the DPT Bill) is to impose the DPT and set the rate at 40 per cent.2

Why two Bills? To avoid breaching section 55 of the Constitution, which provides that ‘laws imposing taxation shall deal only with the imposition of taxation, and any provision therein dealing with any other matter shall be of no effect’, the Parliament has traditionally passed two separate Acts when imposing a tax:

• a Rating Act, which does little more than impose the tax (that is, creates the liability) and stipulates the rate of taxation and

• a separate Assessment Act, which contains all the other provisions setting out the criteria for deductions and the like, the necessary administrative machinery related to assessment, collection, objections, appeals and anti-avoidance provisions and so forth.3

As a result of the above the Diverted Profits Tax Bill 2017 (the DBT Bill), if passed will fulfil the role of the Rating Act and the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 (the Main Bill), if passed, will fulfil the role of the Assessment Act.

However, as noted in a leading tax text ‘this legislative dichotomy is conservative, and many matters traditionally contained in Assessment Acts could legitimately be dealt with in the Rating Act itself’.4

Structure of the Bills The Main Bill has three Schedules:

• Schedule 1 deals with the diverted profits tax (DPT)

• Schedule 2 increases penalties for ‘significant global entities’ that breach their tax reporting obligations

• Schedule 3 amends the Income Tax Assessment Act 1997 (ITAA 1997) to give effect to the Organisation for Economic Co-operation and Development’s (OECD) recommendations regarding transfer pricing.

The DPT Bill is comprised of four items, and sets the rate of the DPT at 40 per cent.

Background Terminology used in this Digest The common meaning of ‘tax avoidance’ relates to practices which seek to circumvent or significantly reduce tax obligations owed to the Commonwealth (some prohibited by law). Courts in Australia, however, have made a semantic distinction between tax avoidance and tax evasion:

• tax avoidance involves using (or attempting to use) lawful means to reduce tax obligations

• tax evasion involves using unlawful means to escape payment of tax.5

1. Parliament of Australia, ‘Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 homepage’, Australian Parliament website. 2. Parliament of Australia, ‘Diverted Profits Tax Bill 2017 homepage’, Australian Parliament website. 3. Australian Constitution. 4. R Woellner, S Barkoczy, S Murphy, C Evans and D Pinto, ‘Australian Taxation Law’, 26th edn, Oxford University Press Australia, Melbourne,

2016, p. 44. See also: Resch v Federal Commissioner of Taxation [1942] HCA 2; (1942) 66 CLR 198, pp. 222-223.

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Whilst the courts have been clear on the difference between tax avoidance (legal) and tax evasion (illegal), popular commentary often uses a range of different terms such as ‘tax minimisation’, ‘tax evasion’, ‘tax planning’ and ‘tax avoidance’ to refer to any and all attempts to reduce taxation (both legal and illegal) and therefore conflates and confuses the two legal concepts of tax avoidance (legal) and tax evasion (illegal).

The DPT operates within the existing ‘general anti-avoidance regime’ (GAAR) framework created by Part IVA of the ITAA 1936. In essence, the DPT deals with global groups (of related entities) who have ‘diverted’ profits from Australia to offshore associates, using arrangements that breach Part IVA of the ITAA 1936, that is, they have a ‘principal purpose’ of avoiding Australian income or withholding tax.

As such, strictly speaking the DPT targets tax evasion rather than avoidance because it will only apply in situations where the relevant ‘scheme’ will have been found to be an unlawful means of escaping or reducing payment of tax under Part IVA of the ITAA 1936. However, to aid readers and to ensure consistency with the Explanatory Materials, this digest uses the term ‘tax avoidance’ to include both tax avoidance and tax evasion.

Background to the Bills The Bills aim to address tax avoidance by multinational corporations (MNCs)6, an issue which has attracted considerable attention in recent years, particularly for Google and Apple.7

The OECD and G20 have been working since 2013 to develop domestic and international instruments that aim to address corporate tax avoidance as part of the Base Erosion and Profit Shifting (BEPS) package.8

Despite this however, a number of jurisdictions have implemented unilateral measures targeting tax avoidance by MNCs that go beyond those recommended by the OECD in the BEPS package, including the United Kingdom9 (which implemented a DPT often referred to as the ‘Google tax’) and Australia through the introduction of the multinational anti-avoidance law (MAAL) in December 2015.10

2016-17 Budget The Bills cover three measures that were announced by the Government in the 2016-17 Budget as part of the ‘Tax Integrity package’:

• increasing penalties for significant global entities

• a new DPT preventing MNCs artificially shifting profits made in Australia offshore to avoid paying tax and

• aligning transfer pricing rules with the latest international guidelines.11

Consultation paper, exposure draft and limited release confidential exposure draft Following the Budget, in May 2016, the Treasury released a consultation paper, Implementing a Diverted Profits Tax.12 The Treasury notes:

The DPT will … help ensure that large multinational corporations pay an appropriate amount of tax on profits made in Australia … [and] will provide the ATO with greater powers to deal with taxpayers who transfer profits, assets or

5. R v Meares (1997) 37 ATR 321 as per Gleeson CJ. 6. S Morrison, ‘Second reading speech: Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017’, House of Representatives, Debates, 9 February 2017, pp. 4-5: ‘This government will not stand for tax avoidance. We will not stand for the deliberate flaunting of our tax laws by major multinational enterprises … And that is why we are introducing this Bill: a Bill that delivers on our promise

to ensure that Australia is at the forefront of the international fight against tax avoidance. This is a Bill that sends a clear message to multinationals—if you wish to operate in Australia, this government expects you to pay your tax, the right amount of tax, and prepare to be challenged and have this legislation and these measures enforced if you choose to violate them.’ 7. See for example J Mather, J Hutchinson and N Khadem, ‘Backlash over Apple’s low taxes’, Australian Financial Review, 7 March 2014, pp. 1, 7; J Dagge, ‘Google pays 16pc tax rate’, Herald Sun, 2 May 2015, p. 53. 8. Organisation for Economic Co-operation and Development (OECD), ‘About BEPS and the inclusive framework’, OECD website. 9. See: Finance Act 2015 (UK), Part 3. 10. Details about the MAAL can be found in: J Olender & L Nielson, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, Bills digest, 45, 2015-16, Parliamentary Library, Canberra, 10 November 2015. 11. Australian Government, Budget measures: Budget paper no. 2: 2016-17, pp. 31, 34-35; The Treasury, Budget 2016-17: making our tax system more sustainable so we can cover the Government's responsibilities for the next generation, The Treasury, Canberra, 2016, p. 10. 12. The Treasury, Implementing a diverted profits tax, consultation paper, The Treasury, Canberra, 3 May 2016.

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risks to offshore related parties using artificial or contrived arrangements to avoid Australian tax and who do not cooperate with the ATO. 13

In November 2016, the Treasury released an exposure draft of the legislation.14 Twenty one submissions regarding the exposure draft were received.15 Whilst the Main Bill differs from the exposure draft, it is consistent with the exposure draft’s overarching design and purpose. However, one notable change is that the Bill now excludes managed investment trusts or similar foreign entities, sovereign wealth funds and foreign pension funds.

The Government then sought further consultation through a limited release confidential Exposure Draft of the final Bill.16

Committee consideration Senate Economics Legislation Committee The Bills were referred to the Senate Economics Legislation Committee for inquiry and report by 20 March 2017.17 The Committee recommended that the Bills be passed.18

Senate Standing Committee for the Scrutiny of Bills The Senate Standing Committee for the Scrutiny of Bills had no comment on the DPT Bill.19 In relation to the Main Bill, the Committee noted a number of concerns including:

• generally under tax law, taxpayers may elect whether to pursue an appeal against the decision of the Commissioner in the Administrative Appeal Tribunal (AAT) or the Federal Court. The Committee noted that no explanation had been provided as to why the Bill provides that in relation to the DPT, a taxpayer may not elect to take their objection to the AAT and, instead, provides that a taxpayer may only appeal to the Federal Court and

• the proposed retrospective application of the changes to Australia's transfer pricing rules proposed by Schedule 3 of the Main Bill.20

The Committee sought the Treasurer's advice as to the justification for the above two measures.21 The Treasurer responded to the Committee on 6 March 2017.22 In relation to appeal rights, the Treasurer advised that the expected complexity of the arrangements that would be examined in any appeal relating to the DPT, and the involvement of large multinational companies as parties, made these cases more suitable for review by the Federal Court rather than the AAT.23 The Committee accepted the Minister’s explanation and asked for the information to be included in the Explanatory Memorandum to the Bill.24

In relation to the retrospective application of the amendments proposed by Schedule 3 to the Bill, the Treasurer advised that the measure ‘provides greater certainty to taxpayers in relation to the pricing of cross-border transactions’.25 The Treasurer further advised that the measure would not have any practical impact until

13. Ibid., p. 2. 14. The Treasury, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017: exposure draft, [29 November 2016]. 15. The Treasury, ‘Diverted profits tax: submissions’, The Treasury website, 23 December 2016. 16. KPMG, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill

2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 5, 1 March 2017, p. 4; ALP Senators, ‘Additional Comments’, Senate Economics Legislation Committee, Report into Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], The Senate, Canberra, March 2017, p. 23. 17. Senate Economics Legislation Committee, Inquiry into the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, The Senate, Canberra. 18. Senate Economics Legislation Committee, Report into Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 22. 19. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 2, 2017, The Senate, Canberra, 15 February 2017, p. 14. 20. Ibid., pp. 38-39. 21. Ibid.

22. Senate Standing Committee for the Scrutiny of Bills, Scrutiny digest, 3, 2017, The Senate, Canberra, 22 March 2017, p. 127. 23. Ibid., p. 128. 24. Ibid., p. 129. 25. Ibid., p. 130.

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taxpayers lodged their 2016-17 returns, which for the majority of affected taxpayers (being large corporate entities) would not be until early 2018 or later and that deferral of the measure could disadvantage taxpayers who had adjusted their affairs in line with the latest OECD requirements.26 The Committee thanked the Treasurer for his response but noted that the response did not indicate whether the retrospective application of the measure would have a detrimental impact on any taxpayer. Accordingly, the Committee drew the matter to the attention of the Senate as a whole.27

Policy position of non-government parties/independents Opposition The Opposition has indicated it will support the introduction of the DPT, whilst also indicating its concerns about the use of debt to shift profits offshore.28

The Australian Greens The Australian Greens support the Bills as part of a wider suite of measures to address multinational tax avoidance, but are concerned that the ATO is not adequately resourced to ensure appropriate enforcement. 29

Other non-government Members and Senators During the Second Reading Debate in the House of Representatives, Ms Rebekha Sharkie (Nick Xenophon Team) noted that whilst she commended ‘the government for taking this key step to combat multinational tax avoidance’, she believed that the Bill should be amended as follows:

• the income threshold used in the definition of 'significant global entities' should be reduced from an annual global income of $1 billion to $250 million

• the 'sufficient foreign tax' test ‘should become more stringent’ and be reduced to 10 per cent

• require ‘up-front disclosure by multinational companies if they believe they may have transactions that would attract a diverted profits tax, to be combined with significant penalties for failing to disclose’.30

At the time of writing the position of other non-government Members and Senators on the Bills was not clear.

Position of major interest groups The majority of interest groups did not indicate unequivocal support or opposition to the Bill, but rather generally focused on specific technical issues related to the drafting of the Bill. Those issues are discussed under the heading ‘Key issues and provisions’ below.

However, there were broader policy issues raised by a number of major interest groups.

The DPT as unilateral action to combat tax evasion A number of major interest groups expressed the view that introducing the DPT was unilateral action inconsistent with the OECD BEPS Action Plan items, and hence risked undermining multilateral efforts to combat tax evasion. KPMG argued:

The impression that the DPT lies outside the agreed OECD BEPS Action Plan items is a very strong one in the international tax community. This is, and should be, a very real concern. That concern partly lies in detriment that Australia faces in being perceived to be a tax “outlier" on international norms. This potentially impacts on inward investment. The concern also partly lies in the precedent our DPT rules create for other countries to put in place

26. Ibid.

27. Ibid., p. 131. 28. A Leigh (Shadow Assistant Treasurer), Turnbull government's phoney war on the multinational tax avoiders continues, media release, 9 February 2017. 29. A Bandt, ‘Second reading speech: Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017’, House of Representatives,

Debates, (proof), 21 March 2017, p. 54. 30. R Sharkie, ‘Second reading speech: Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 ‘, House of Representatives, Debates, (proof), 21 March 2017, p. 52.

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rules outside the newly negotiated OECD international tax framework. This potentially impacts outward investment. 31

The Minerals Council of Australia (MCA) noted that ‘the OECD itself has warned countries against unilateral measures like the DPT’ and also argued that introducing a DPT would be ‘a parochial measure’ that would undermine ‘Australia’s standing as a stable and predictable place to invest’.32 For its part, the OECD has argued that:

Many BEPS strategies take advantage of the interaction between the tax rules of different countries, which means that unilateral action by individual countries will not fully address the problem. In addition, unilateral and uncoordinated actions by governments responding in isolation could result in double—and possibly multiple— taxation for business. This would have a negative impact on investment, growth and employment globally. There is therefore a need to provide an internationally coordinated approach which will facilitate and reinforce domestic actions to protect tax bases and provide comprehensive international solutions to respond to the issue.

33

However, Mr Pascal Saint-Amans, the Director of the OCED’s Centre for Tax Policy and Administration, told the Senate Economics References Committee Inquiry into Corporate tax avoidance that:

We tend to think that unilateral measures will be better after we have completed the action plan, but countries are sovereign and it is for them to decide what to do. 34

In contrast to the views expressed by KPMG and the MCA, Tax Justice Network Australia argued that:

Reliance on only multilateral measures will ensure that greater levels of tax cheating will be maintained as there are foreign jurisdictions that have demonstrated that they are willing to design their tax laws to assist multinational enterprises in being able to carry out cross-border tax avoidance … The use of some unilateral measures is therefore essential to combat the activities of the minority of foreign jurisdictions that actively seek to facilitate cross-border tax avoidance.

The Diverted Profits Tax (DPT) is necessary because of the inadequacy of the OECD BEPS Actions 8, 9 and 10 proposals on transfer pricing, and the weak proposals on Controlled Foreign Corporations (CFC) rules in Action 3. This means that multinational enterprises are still free to dodge taxes by locating activities such as ownership of Intellectual Property (IP) rights in low-tax jurisdictions, and treat operating affiliates in source countries as ‘stripped risk’ producers or distributors. The proposed DPT will help combat the "cash box" arrangements offered by the governments of Luxembourg and Switzerland, and the Dutch government provided IP management entity arrangements.

35

‘Chilling’ effect on investment A number of submissions argued that the DPT would reduce the attractiveness of Australia as a destination for foreign investment. For example, the Australian Taxpayers Alliance (ATA) argued that the ‘chilling effect on investment’ into Australia ‘requires more evidence to be sound … particularly considering the broader issue of tax competition’.36

31. KPMG, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 1 March 2017, p. 2. 32. Minerals Council of Australia (MCA), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 10, March 2017, p. 1. 33. OECD, ‘BEPS—frequently asked questions’, OECD website, n.d. 34. P Saint-Amans (Director, Centre for Tax Policy and Administration, OECD), Evidence to Senate Economics References Committee: inquiry into

corporate tax avoidance, 4 April 2015, p. 65. 35. Tax Justice Network Australia, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 8, 1 March 2017, p. 1. 36. Australian Taxpayers' Alliance (ATA), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating

Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 4, 1 March 2017, p. 3.

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The MCA argued that introducing a DPT would undermine ‘Australia’s standing as a stable and predictable place to invest’.37 The Law Council of Australia also expressed concern over the impact of a DPT on foreign investment into Australia, arguing:

… implementing a DPT will not attract business to Australia. In fact, it may drive business outside of Australia. For most multinational groups, operations in Australia form a small component of their overall global footprint. 38

[emphasis added]

Breadth of application A number of submissions expressed concern about the breadth of application of the DPT. For example, the Corporate Tax Association (CTA) and Group of 100 (G100) argued that in its current form the DPT has ‘the potential to apply to almost 60 percent of offshore transactions undertaken by companies operating in Australia, whose only potential protection is the sufficient economic substance test, which is fraught with interpretive difficulties’.39

The LCA expressed concern that the DPT is likely to impact on a much greater number of taxpayers than under the MAAL. The LCA argued that the application of the 80 percent threshold requirement (modelled on the UK approach) would result in most jurisdictions in the world being caught under the Australian DPT, whereas a much lower proportion of tax jurisdictions around the world are captured by the UK DPT threshold (because of the UK’s lower corporate tax rate).40

Interaction with tax treaty obligations A number of submissions expressed concern about how the DPT would interact with Australia’s tax treaties.

For example, LCA noted that because the DPT measure is constructed as part of Australia’s GAAR and included in Part IVA of the ITAA 1936, it is beyond the scope of Australia’s double tax agreements (DTAs) and their dispute resolution provisions and therefore creates the risk of double taxation.41

Likewise the CTA and G100 noted that the inclusion of the DPT in Part IVA of the ITAA 1936 ‘will essentially shield it from being overridden by tax treaties’.42 The CTA and G100 argued that this would have the ‘perverse effect’ of protecting the DPT, ‘a provision designed to create’ the outcome that tax treaties ‘are specifically aimed at preventing, that being double taxation.’43 The CTA G100 recommended that Australia should withdraw its reservations that exclude the DPT, and therefore allow taxpayers who are subject to a DPT assessment access to binding mutual agreement procedure arbitration.44

The MCA argued that the DPT should not be excluded from the operation of the international dispute resolution procedures contained in Australia’s DTAs or the proposed OECD multilateral Instrument (BEPS Action item 14).

37. Minerals Council of Australia (MCA), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 1. 38. Law Council of Australia (LCA), Submission, Treasury consultation paper, implementing a diverted profits tax, May 2016, 30 June 2016, p. 3. The LCA noted in its submission to the Senate Economics Legislation Committee inquiry that its submissions on the exposure draft of the Bill

‘continue to stand’ and, in turn, that submission noted that the LCA ‘reiterates the submissions it made in relation to the Discussion Paper’: Law Council of Australia (LCA), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 9, 2 March 2017, p. 1, incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 2. 39. Corporate Tax Association (CTA) and Group of 100 (G100), Submission to Senate Economics Legislation Committee, Treasury Laws

Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 11, 3 March 2017, p .2. 40. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 9, 2 March 2017, p. 3, incorporating the LCA’s submission to Treasury regarding

the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 2; LCA, Submission, Treasury Consultation Paper, Implementing a Diverted Profits Tax, 30 June 2016, pp. 4-5. 41. Ibid., pp. 1-2. 42. CTA and G100, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p .3. 43. Ibid.

44. Ibid.

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This was, it was argued, because such an exclusion ‘raises the risk of double taxation for Australian taxpayers’ and undermines ‘international efforts to avoid this’.45 Further, the MCA argued:

If Australia excludes the DPT from independent binding arbitration (under the OECD Multilateral Instrument, BEPS Action 14) the ATO could effectively use the DPT to ignore the arm’s length principle and coerce taxpayers into accepting the ATO’s position. This will circumvent access to independent binding arbitration as a means of resolving a genuine cross border dispute with another tax authority and give the ATO unilateral powers to deny a fair hearing be given to transfer pricing issues raised by taxpayers and other taxing authorities, each of whom have a legitimate interest in the outcome.

46

Interaction with other tax laws A number of submissions expressed concern regarding how the DPT would interact with other tax laws. One common area of concern was the interaction between the DPT and transfer pricing rules.

For example, the Australian Financial Markets Association (AFMA) proposed that the DPT should not be able to operate in circumstances where any adjustment under Division 815 of the ITAA 1997 (which deals with cross-border transfer pricing) would operate to reduce the tax benefit determined under the DPT.47

The CTA and G100 also expressed similar views, noting that the interaction between the DPT and the transfer pricing reconstruction provisions in section 815-130 of the ITAA 1997 ‘which are yet to be tested’—would be a key issue.48 As a result, the CTA and G100 argued that it is necessary to ensure that the DPT is the provision of ‘last resort’ and therefore to prevent the use of the DPT as ‘leverage during transfer pricing disputes’ the use of the DPT should be ‘legislatively limited to cases where all other relevant laws have been explored’.49

The LCA also argued that the DPT should be limited to ensure that it does not apply where a taxpayer and the ATO are properly working through a transfer pricing matter. In particular, the LCA expressed concern that the Main Bill would allow the ATO to pursue the DPT alternatively to, and in parallel to, a transfer pricing issue even where a taxpayer was engaging appropriately with the ATO to resolve any outstanding issues. As a result, the LCA recommended that the Bill be amended to ensure that the DPT should operate on a secondary basis (that is, it should not be allowed to be used in parallel with other proceedings).50

The MCA also expressed similar concerns, arguing that the DPT ‘can be applied to ordinary cross-border dealings as an alternate to transfer pricing provisions’ in Division 815 of the ITAA 1997 and hence could be used ‘to adopt non-standard transfer pricing positions’.51 This, it was argued, would mean that it would be:

entirely possible for a commercial transaction to be compliant with the internationally agreed tax rules, but for the ATO to override these rules and apply the DPT to adopt unilateral transfer pricing positions, resulting in double taxation and increasing the cost of doing business. 52

The MCA argued that as a purported ‘measure of last resort’, under the DPT the ATO should ‘exhaust all information request avenues’ before applying the DPT and that this should:

include all powers available under the current taxation laws and exchange of information provisions that are contained in Australia’s Double Taxation Agreements (DTAs) and Taxation Information Exchange Agreements (TIEAs). 53

45. MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 4. 46. Ibid., p. 4. 47. Australian Financial Markets Association (AFMA), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment

(Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 7, 1 March 2017, pp. 2-3. 48. CTA and G100, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p .2. 49. Ibid., p. 2. 50. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017

and Diverted Profits Tax Bill 2017 [provisions], op. cit., pp. 1-2. 51. MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3. 52. Ibid.

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Financial implications The Explanatory Memorandum estimates the financial impact of the introduction of the DPT will be $100.0m per year from 2018-19 onwards.54 However, the Explanatory Memorandum indicates the financial impact of increasing penalties for significant global entities (Schedule 2) and amending operation of transfer pricing rules Schedule 3) are unquantifiable, as indicated in the table below.

Table 1: financial impact of measures proposed by the Bills

Measure 2015-16 2016-17 2018-19 2019-20

Introducing the DPT Nil Nil $100.0m $100.0m

Increasing penalties for significant global entities ‘an unquantifiable gain to revenue over the forward estimates period’

Amending operation of transfer pricing rules ‘an unquantifiable gain to revenue over the forward estimates period’

Source: Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, pp. 3 and 5.

The decision to record no estimate of the financial impact likely reflects the difficulty of forecasting the effect of those measures rather than the likelihood they will have nil impact.

Statement of Compatibility with Human Rights As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bills are compatible.55

Parliamentary Joint Committee on Human Rights The Parliamentary Joint Committee on Human Rights considered that the Bills did not raise any human rights concerns.56

Key issues and provisions Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 Schedule 1 Objects of the DPT Proposed section 177H of the ITAA 1936, at item 13 of Schedule 1, provides that the objects of the DPT are:

• to ensure that the Australian tax payable by significant global entities properly reflects the economic substance of the activities that those entities carry on in Australia

• to prevent those entities from reducing the amount of Australian tax they pay by diverting profits offshore through contrived arrangements between related parties and

• to encourage significant global entities to provide sufficient information to the Commissioner to allow for the timely resolution of disputes about Australian tax.57

Entities captured by the DPT The DPT will only apply where the taxpayer is a ‘significant global entity’ for the income year and:

53. Ibid., p. 3. 54. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, p. 3. 55. The Statement of Compatibility with Human Rights can be found at pages 65-66 (Schedule 1), 81 (Schedule 2) and 86 (Schedule 3) of the Explanatory Memorandum to the Bill.

56. Parliamentary Joint Committee on Human Rights, Report, 1, 2017, 16 February 2017, pp. 32-33. 57. Income Tax Assessment Act 1936.

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• a foreign entity that is an associate of the taxpayer is connected with the scheme and

• the relevant taxpayer is not a specified kind of collective investment vehicle.58

Section 960-555 of the ITAA 1997 defines a ‘significant global entity’ as one that has annual global income of $1 billion or more in that income year or where it is a member of a group of entities that are consolidated for accounting purposes as a single group, and one of the other members of the group is a global parent entity whose annual global income is $1 billion or more.59

Definition of significant global entity captures Australian entities As noted by Greenwoods & Herbert Smith Freehills (GHSF), as drafted the Bill ensures that the DPT ‘can apply to any taxpayer so long as it has an associate which is a foreign entity’.60

Likewise, AFMA (which represents the interests of Australia's wholesale banking and financial markets) noted that a substantial portion of its members would be considered ‘significant global entities’ (SGEs) for the purposes of the ITAA 1997 and therefore would fall within the operation of the proposed amendments set out in the Main Bill.61 The CTA and G100 also noted that:

… the definition of ‘significant global entity’ includes corporates controlled by Australian residents and only have Australian operations, where there is no potential loss of revenue from mispriced international related party transactions. 62

As a result, the CTA and G100 recommended that the Bill should be amended to provide that SGEs that are controlled by Australian residents and have no foreign operations should be excluded from the operation of the DPT.63

Entities specifically excluded from DPT The Bill specifically excludes certain types of SGEs from the operation of the DPT. Proposed paragraph 177J(1)(f) of the ITAA 1936, at item 13 of Schedule 1, excludes the following kinds of collective investment vehicles:

• managed investment trusts

• foreign collective investment vehicles with wide membership

• foreign entities owned by a foreign government

• complying superannuation entities and

• foreign pension funds.

The Explanatory Memorandum notes that these SGEs are excluded from the DPT as they are considered ‘low risk from an integrity perspective’ and thus ‘ensures that these entities do not face an unnecessary compliance burden as a result of the introduction of the DPT’.64

Conduct captured by the DPT If the taxpayer falls within the DPT, proposed section 177J provides it will only apply when the following element are satisfied:

• there was a ‘scheme’ in relation to a ‘tax benefit’

58. Proposed paragraphs 177J1(c), (d), (e) and (f) of the ITAA 1936, at item 13 of Schedule 1. 59. Income Tax Assessment Act 1997. 60. Herbert Smith Freehills (HSF), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 6 March 2017, incorporating HSF’s submission to the exposure draft of

the Bill (16 December 2016), p. 12; proposed paragraphs 177J(1)(c) and (d) of the ITAA 1936. 61. AFMA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 1. 62. CTA and G100, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance)

Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 5. 63. Ibid.

64. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 28.

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• the taxpayer obtained a tax benefit in connection with the scheme (or would have, but for the operation of section 177F of the ITAA 1936)

• it would be concluded that the person, or one of the persons, who entered into or carried out the scheme did so for a principal purpose of:

• enabling the taxpayer to obtain a tax benefit or • enabling the taxpayer to both obtain a tax benefit and reduce a foreign tax liability or • enabling the taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit or • enabling the taxpayer and another taxpayer (or other taxpayers) both to obtain a tax benefit and to

reduce one or more of their liabilities to tax under a foreign law and

• it is ‘reasonable to conclude’ that the $25 million de minimus threshold test, the sufficient foreign tax test or the sufficient economic substance test do not apply in relation to the relevant tax payer in relation to the tax benefit obtained from the scheme.65

These are discussed below.

Scheme generally The DPT will only apply to a ‘scheme’—broadly defined to be any agreement, arrangement, understanding, plan, scheme, proposal, action, course of action, course of conduct, promise or undertaking, whether it was express or implied, or enforceable or intended to be enforceable.66

Proposed subsection 177J(7) specifically provides that the DPT applies whether or not the scheme has been or is entered into or carried out in Australia, outside of Australia or partly in Australia and outside of Australia.

Tax benefit Subject to the principal purpose test (discussed below), the DPT will only apply to a scheme related to obtaining a ‘tax benefit’ (also referred to as tax effects). Section 177C of the ITAA 1936 specifies a range of tax benefits that can be obtained under the Australian income tax law, and to which the DPT will apply, including:

• an amount not being included in the assessable income of the taxpayer where that amount would have been included, or might reasonably be expected to have been included without the scheme

• a deduction being allowable to the taxpayer where the whole or a part of that deduction would not have been allowable without the scheme

• a capital loss being incurred by the taxpayer where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred without the scheme

• a foreign income tax offset being allowable to the taxpayer where the whole or a part of that foreign income tax offset would not have been allowable, or might reasonably be expected not to have been allowable, without the scheme

• an exploration credit being issued to the taxpayer where the whole or a part of that exploration credit would not have been issued, or might reasonably be expected not to have been issued, without the scheme and

• the taxpayer not being liable to pay withholding tax on an amount where the taxpayer either would have, or might reasonably be expected to have, been liable to pay withholding tax without the scheme.67

In addition to the above, proposed subsection 177J(3) specifically provides that deferral of a taxpayers tax under a foreign law is taken to be a reduction of those liabilities (and therefore a tax benefit) unless there are ‘reasonable commercial grounds for the deferral’. Under the Bill, the type of tax benefit obtained determines how the amount of a taxpayers DPT liability is calculated (discussed below).68

65. Proposed subsection 177J(1) of the ITAA 1936, proposed paragraphs 177J(1)(a), (b) and (g). 66. Income Tax Assessment Act 1936 (Cth), definition of ‘scheme’ at subsection 177A(1). 67. Ibid., paragraphs 177C(1)(a)-177C(1)(bc); section 177CB. 68. See proposed subsections 177L(6) and 177P(2).

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Principal purpose test The DPT will only apply to schemes where it would be concluded (having regard to various matters) that the person, or one of the persons, who entered into or carried out the scheme (or any part of the scheme) did so for a principal purpose of, or for more than one principal purpose, that includes a purpose of:

• enabling the relevant taxpayer to:

- obtain a tax benefit or - both to obtain a tax benefit and to reduce one or more of the relevant taxpayer’s liabilities to tax under a foreign law or • enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to:

- obtain a tax benefit or - both to obtain a tax benefit and to reduce one or more of their liabilities to tax under a foreign law whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.69 The inclusion of the taxpayer’s foreign tax liability for the principal purposes test broadens the scope of the anti-avoidance provisions contained in the Bill. If the foreign tax benefits were not taken into account, a scheme that had a small tax benefit in Australia may not satisfy the principal purposes test when taking into account the matters set out in proposed subsection 177J(2). The combined value of the Australian tax benefit and the foreign tax benefit however may be sufficient to meet the definition of a principal purpose.

As noted in the Bills Digest to the Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, the general anti-avoidance provisions in section 177D in Part IVA of the ITAA 1936 deal with schemes entered into for the sole or dominant purpose of obtaining a tax benefit. However, it has been difficult for the Commissioner to prove that an entity has undertaken a scheme, for the ‘sole or dominant purpose’ of obtaining a tax benefit.70

As a result, the Bill adopts the ‘principal purpose’ test used in the MAAL, and hence applies a lower threshold than that used in the GAAR provisions in Part IVA of the ITAA 1936 (the sole or dominant purpose test).

Concerns about the use of the principal purpose test A number of submissions expressed concern at the adoption of the ‘principle purpose test’ in the DPT. For example, the MCA argued that as result of the lower threshold:

… this means that legitimate transactions entered into for a principal purpose that is not to obtain a tax benefit may be deemed to have been entered into for such a purpose and subject to the DPT. This is because it could be concluded, objectively, that obtaining a tax benefit might have been a principal purpose. Given that any transaction with a related party in a country with a tax rate lower than 24 per cent (which is most other countries and the OECD) will yield benefits of at least 6 cents in every dollar, most will come within the scope of the DPT. Indeed, it will be difficult to resist this assertion on objective grounds and many taxpayers are likely to find themselves subject to the DPT and looking to the ‘economic substance’ test for exclusion. Australia’s relatively high tax rate will ensure that many large corporate taxpayers dealing internationally will be drawn into the scope of this tax without any intention of avoidance at all. There is not real tax avoidance threshold in the application of the DPT.

71 [emphasis

added]

The CTA and G100 argued that the DPT should adopt a higher threshold—the ‘dominant purpose test’—because of the ‘significant implications associated with the DPT being imposed’.72

The LCA also expressed concern about the ‘principal purpose’ test used in proposed section 177J. In particular the LCA noted its concern:

69. Proposed paragraph 177J(1)(b). 70. J Olender and L Nielson, Tax Laws Amendment (Combating Multinational Tax Avoidance) Bill 2015, Bills digest, 45, 2015-16, Parliamentary Library, Canberra, November 2015, p. 16. 71. MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017

and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3. 72. CTA and G100, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 5 of Appendix A.

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• that how significant a purpose must be before it is properly characterised as a ‘principal’ purpose is not clear and

• the fact that a person can have multiple principal purposes, and its impact on the analysis of whether the particular purpose under consideration qualifies as a principal purpose ‘is also unclear’.73

The LCA also noted that the principal purpose test is satisfied where a person has a principal purpose of enabling one or more taxpayers to:

• obtain a tax benefit or

• obtain a tax benefit and reduce a liability tax under a foreign law.

The LCA argued that it was not apparent why a purpose of reducing a foreign tax liability would be a relevant consideration when assessing whether the scheme is one to which the DPT regime would apply. The schemes to which the DPT appeared to be directed were those designed to reduce Australian tax liability by diverting Australian profits offshore, and therefore consequentially increasing foreign tax liability by an amount less than the equivalent Australian tax liability. The LCA argued that in those circumstances the inclusion of a purpose of reducing foreign tax liability in the principal purpose test appears counterintuitive.74

Support and rationale for the use of the principal purpose test Not all of the submissions expressed concern about the use of the principal purpose test instead of the sole or dominant purpose test, and some expressed support for its use in the DPT.

For example, KPMG noted that whilst the DPT seeks to lower the threshold used from the ‘dominant purpose’ to ‘one of the principal purposes’ that terminology is consistent with the recently introduced MAAL and with the OECD's ‘anti-treaty shopping language’. KPMG stated ‘we accept that the business world, tax community and judiciary will need to get used to this lower bar.’75

Likewise, Associate Professor Ting noted that as with most GAAR provisions the DPT is ‘inherently uncertain’, and because the DPT uses concepts (including the ‘principal purpose’ test) that are ‘new and untested’, this is ‘possibly a necessary evil for all GAARs in the world’.76 He also noted that experience with Part IVA of the ITAA 1936 suggests that the underpinning concepts ‘are likely to be controversial’ and will almost certainly be the focus of ‘complex and difficult’ litigation in the future, but that ultimately ‘the introduction of a DPT as a unilateral measure is a welcoming step in the right direction in the war against BEPS’ and that the Government ‘should be commended for taking this course of action.’77

The Tax Justice Network Australia likewise noted that it supported the application of the DPT where ‘the arrangement was designed (as one of its purposes) to secure a tax reduction for the relevant multinational enterprise (MNE) or for other taxpayers’.78

For its part, the Government notes that whilst the ‘principal purpose or more than one principal purpose’ threshold is lower than the ‘sole or dominant purpose threshold’ used in subsection 177D(1) of the ITAA 1936 it was consistent with the ‘principal purpose or more than one principal purpose’ test is used in the MAAL and:

… reflects the language used in the 2015 OECD Report titled ‘Preventing the Granting of Treaty Benefits in Inappropriate Circumstances’. The report aims to reduce or address treaty abuse through an anti-abuse rule based on ‘one of the principle purposes of any arrangements or transactions’. 79

73. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 5.

74. Ibid.

75. KPMG, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 5, 1 March 2017, p. 10. 76. Associate Professor Antony Ting (University of Sydney), Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 3, n.d., pp. 2-3. 77. Ibid., p. 2. 78. Tax Justice Network Australia, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational

Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3.

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Factors to be considered when applying the principle purpose test Provided that the scheme is not excluded by proposed paragraph 177J(1)(g) (discussed below), proposed subsection 177J(2) provides that when applying the principal purpose test to a scheme, regard must be had to a number of matters including:

• the existing matters provided under subsection 177D(2) of the ITAA 1936 (discussed below)

• the extent to which non-tax financial benefits that are quantifiable have resulted, will result, or may reasonably be expected to result, from the scheme

• the result, in relation to the operation of any foreign law relating to taxation, that (but for the DPT) would be achieved by the scheme and

• the amount of the tax benefit.

Existing matters to be considered In determining whether the principal purpose test applies to a scheme, proposed subsection 177J(2) will require the following matters referred to in section 177D(2) of the ITAA 1936 to be considered including:

• the manner in which the scheme was entered into or carried out

• the form and substance of the scheme

• the time at which the scheme was entered into and the length of the period during which the scheme was carried out

• any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme and

• any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme.

Quantifiable non-tax financial benefits Proposed paragraph 177J(2)(b) provides that when applying the principal purpose test, the extent to which non-tax financial benefits that are quantifiable have resulted, will result, or may reasonably be expected to result, from the scheme must be considered.

The Explanatory Memorandum notes that non-tax financial benefits are ‘quantifiable commercial benefits arising from a scheme’ that are computable and identifiable amounts of economic value generated from the scheme.80 However, tax outcomes ‘are not included in this quantification’ and that the quantification of non-tax financial benefits must be ‘based on the value of those benefits at the time of entering into the scheme’.81

The Explanatory Memorandum notes that ‘if the scheme produces significant quantifiable non-tax financial benefits’ this could be ‘a strong indicator that the purpose of the scheme was not to produce the tax benefit.’82 The Explanatory Memorandum notes that consideration of non-tax financial benefits ‘should generally be based on the anticipated outcomes at the time of entry into the scheme’ and that provided the anticipated outcomes were ‘based on reasonable commercial assumptions’ the fact that the anticipated outcomes do not eventuate does not in itself indicate a principal purpose of obtaining a tax benefit. However, the anticipated outcomes may carry less weight where the scheme has been implemented in a different manner to that which was anticipated at the outset of the scheme.83

79. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 21. 80. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 23. 81. Ibid.

82. Ibid.

83. Ibid., pp. 23-24.

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The Explanatory Memorandum notes a number of examples of non-tax financial benefits, including but not limited to:

• any productivity gains and/or cost savings in connection with the scheme

• the value added, or synergies resulting from any assets used, functions performed or risks assumed in connection with the scheme

• where the scheme involves the transfer of assets used, functions performed or risks assumed in connection with the scheme, the extent to which those assets, functions and risks replace or merely replicate the existing assets, functions and risks in the global value chain

• any location specific benefits—for example, reduced distribution costs from proximity to the customer base or improved access to staff with the relevant skill set required to undertake economically significant functions

• any reduction of non-income tax costs resulting from the scheme (for example, tariffs, payroll taxes and stamp duties) and

• any provision of non-tax Government incentives in connection with the scheme.84

It was also noted that a taxpayer may provide evidence to support the non-tax financial benefits of the scheme such as representations made to management and Boards of the entities involved in a restructure or evidence of the non-tax financial benefits that have actually accrued to date and that are anticipated to accrue in the future.85

Concerns about the exclusions of non-quantifiable tax benefits The LCA argued that the inclusion of the factors in proposed paragraphs 177J(2)(b) to (d) were unnecessary and may ‘obfuscate the application of the [principal] purpose test’ and therefore should be deleted.86

The LCA argued that the inclusion of quantifiable non-tax financial benefits in proposed paragraph 177H(2)(b), if it were to be retained, should be amended to provide that it is a complete defence to the DPT if non-tax financial benefits exceed the tax benefit, as is the case in the UK.87

Further, the LCA also recommended that non-quantifiable non-tax financial benefits ‘ought also to be relevant to the principal purpose test analysis’ and this could include for example ‘reputational impacts, market practice, regulatory impact or simple inconvenience’.88

The Tax Institute expressed similar concerns to those noted above.89

The amount of the tax benefit Proposed paragraph 177J(2)(d) of the ITAA 1936 provides that the amount of the tax benefit arising from the scheme is a matter to be considered when applying the principal purpose test. Whilst the Explanatory Memorandum does not provide direct guidance as to how this factor is to be applied, it would appear that it would be weighed alongside the other factors in proposed subsection 177J(2) when determining if the overall facts and circumstances of the scheme point to an objective purpose of enabling a taxpayer to obtain a tax benefit.

As such, it would appear that where a very large tax benefit resulted from the scheme, in the absence of substantial quantifiable non-tax financial benefits (for example) it may be reasonable to conclude that a principal purpose of enabling a taxpayer to obtain a tax benefit.

84. Ibid.

85. Ibid.

86. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, op. cit., p. 6.

87. Ibid.

88. Ibid.

89. Tax Institute, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 6, 1 March 2017, p. 9.

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Modifications where thin capitalisation provisions apply The thin capitalisation modification contained in proposed subsections 177J(4) and (5) is intended to preserve the role of Division 820 of the ITAA 1997 (which deals with debt deductions) in respect of its application to an entity's amount of debt.90 It applies where:

• the thin capitalisation provisions (Division 820 of the ITAA 1997) apply to the relevant taxpayer

• the DPT tax benefit includes all or part of a debt deduction91and

• the calculation of the amount of the DPT tax benefit involves applying a rate to a debt interest.92

The Explanatory Memorandum provides the following explanation of how proposed subsections 177J(4) and 177J(5) are intended to operate:

• first, consider if the DPT tax benefit includes (in total or as part of the tax benefit) a debt deduction. If it does, determine the debt interest that would have been issued and the rate that would have applied had the scheme not been entered into or carried out

• second, modify the calculation of the DPT tax benefit so that the rate for a particular debt interest is applied to the actual amount of debt for that debt interest.93

Modifications where controlled foreign company provisions apply In simple terms, a controlled foreign corporation (CFC) is a company that is a resident of a foreign jurisdiction where at least one of the ‘control tests’ set out in section 340 of the ITAA 1936 applies at any time (but in particular at the end of a statutory accounting period of the company):

• the ‘strict control’ test: five or fewer Australian entities have a minimum 50% associate inclusive control interest in the company94

• the ‘assumed controller test’ test: a single Australian entity (and its associates) has at least a 40% control interest in the foreign company95 or

• the ‘de facto control’ test: the company is actually controlled by a group of five or fewer Australian entities either alone or together with their associates, irrespective of the interests in it.96

The CFC modification contained in proposed section 177J(6) applies if the relevant foreign entity that carried out or entered into the scheme (in part or in whole) or was otherwise connected to the scheme is a CFC within the meaning of Part X of the ITAA 1936. If so, the DPT tax benefit is disregarded to the extent that it arises from attributable income (within the meaning of that Part X of the ITAA 1936) of the foreign entity in respect of:

• the relevant taxpayer or

• an associate (as defined by section 318 of the ITAA 1936) of the relevant taxpayer.97

This means that attributable income arising from the scheme that is:

• included in the assessable income of the relevant taxpayer or

• included in the assessable income of an associated entity (the CFC)

90. Income Tax Assessment Act 1997. 91. As defined in section 820-40 of the ITAA 1997, these include any costs directly incurred in obtaining or maintaining a debt interest such as interest or amounts in the nature of interest, guarantee fees, line fees and discounts on commercial paper. 92. Proposed subsection 177J(4). 93. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017,

p. 19.

94. Income Tax Assessment Act 1936, paragraph 340(a). 95. Paragraph 340(b) of the Income Tax Assessment Act 1936 provides that there is a rebuttable presumption that such a shareholder controls the foreign company and the company is therefore a CFC. The presumption can be rebutted if the shareholder can demonstrate that the company is in fact controlled by another, unassociated entity. For example, although an Australian entity may have a 45% control interest, the

control test will not be satisfied where there is a single unassociated foreign entity holding a 55% control interest. 96. Income Tax Assessment Act 1936, paragraph 340(c). 97. The attributable income of a CFC is calculated using the tax rules applicable to Australian resident companies as modified for the purposes of

Pt X of the ITAA 1936. The amounts that are included in the attributable income of a CFC depend on whether the CFC is a resident of a ‘listed’ or ‘unlisted’ country.

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does not form part of the DPT tax benefit. Proposed section 177J(6) therefore prevents double taxation by ensuring that the attributable income of the relevant taxpayer or associate involved in the scheme (which is taxable) does not form part of the DPT tax benefit.98

Schemes excluded from the DPT As noted earlier, a scheme is excluded from the DPT by proposed paragraph 177J(1)(g) if, in relation to the relevant taxpayer and the relevant tax benefit one or more of the following three tests are satisfied:

• the $25 million income test (proposed section 177K)

• the sufficient foreign tax test (proposed section 177L)

• the sufficient economic substance test (proposed section 177M).

These are discussed below.

The $25 million income test Proposed section 177K introduces a de minimis threshold to exempt entities with Australian turnover of less than $25 million from the DPT (the $25 million income test). Broadly speaking, the $25 million income test will apply where the sum of:

• the assessable income, exempt income and non-assessable non-exempt income of the relevant taxpayer

• the assessable income of any other associated entities that are members of the same global group

• and (if the DPT tax benefit relates to an amount not being included in assessable income) the amount of the DPT tax benefit does not exceed $25 million.99

The purpose of the $25 million income test is to ensure that the DPT does not apply in circumstances where the operations of the relevant taxpayer and associated Australian entities are relatively small.100

The sufficient foreign tax test Broadly speaking, this exception requires that the increase in foreign tax liability as a result of the diversion of profit (income) offshore is 80% or more of the reduced Australian tax liability (that is, it results in a 20% or less reduction in the Australian tax liability).

There are two modifications to this exception:

• regulations may be made to modify the meaning of ‘foreign tax liability’101 and

• any reduction in Australian tax liability is itself reduced to the extent that Australian withholding tax is paid on the diverted income.102

Criticisms of the sufficient foreign tax test A number of submissions criticised the 80% threshold used in the sufficient foreign tax test (sometimes referred to as the 20% tax reduction test103).

The CTA and G100 noted with concern that whilst the sufficient foreign tax test was ‘intended to operate as a carve out’ it would potentially impact on ‘all transactions involving a foreign related entity’ located in a jurisdiction that ‘imposes a corporate income tax rate of less than 24%’.104 The CTA and G100 argued that ‘this

98. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 19. 99. Proposed section 177K. 100. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017,

p. 31.

101. Proposed subsection 177L(3). 102. Proposed subsection 177L(7). 103. Senate Economics Legislation Committee, Report into Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], The Senate, Canberra, March 2017, p. 14.

104. CTA and G100, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p .2.

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essentially means that countries that are trading partners, rather than tax havens’ will be targeted by DPT.105 For example, the CTA and G100 noted that the sufficient foreign tax test would, when applied to Australia's current corporate tax rate of 30 percent, capture transactions involving entities located in Switzerland, Singapore, Hong Kong, or Ireland that ‘make up 40 % of related party transactions’ with Australian entities.106

The CTA and G100 also noted with concern and that given the early indications from the US around corporate tax reform under the Trump administration and falling corporate tax rates elsewhere in the world, it would be possible that ‘all related party transactions with the US’ would fall within the ambit of the proposed DPT, and that it may also capture a large proportion of other related party transactions conducted between Australian entities and entities located in Australia's other major trading partners (such as the UK).107

The LCA expressed similar concerns, arguing that the 80 percent threshold—modelled on the UK’s DPT—is too high and, because the UK corporate tax rate of 20 percent is significantly lower than Australia's, the application of the 80 percent threshold requirement would result in most jurisdictions in the world been caught under the proposed DPT. Further, the LCA argued that it was difficult to envisage that MNCs undertaking related party transactions with related entities in tax jurisdictions with tax rates of 24 percent or less can be seen (automatically) as an overt attempt to reduce the overall tax payable in a significant way and argued that if the 80 percent threshold is implemented, it may have the practical result of encouraging Australian companies to choose to do business only with unrelated parties, which does not appear to be a valid tax policy setting or desirable economic or commercial outcome.108

GHSF also criticised the 80% threshold used in the sufficient foreign tax test, stating ‘the sufficient foreign tax test effectively sets an unrealistically high bar for the foreign tax of an effective rate of 24% (being 80% of the Australian rate)’.109

Both the LCA and GHSF recommended that the threshold used in a sufficient foreign tax test should be lowered to 50 percent.110 In contrast however, Tax Justice Network Australia noted that:

TJN-Aus is concerned that the 20 per cent tax reduction threshold to apply the DPT may be too high. For example, a multinational enterprise with profits of $100 million in Australia would be permitted to avoid up to $20 million before being caught by the DPT. Given the threshold test does not require the ATO to take action, but allows them to, provided they have cause to believe the test of the transaction lacking economic substance applies, a lower threshold allows the ATO more ability to take action. It means if a transaction is entered into that obviously lacks economic substance, the ATO will have the option to take action. The ATO will still need to assess the amount of revenue to be recovered against the cost of the ATO taking action.

111

Tax Justice Network Australia therefore recommend a threshold of a 10 per cent tax reduction, and further recommend that ‘the ATO should be able to also take action against transactions that result in a $5 million tax reduction if they lack economic substance, even if this is below the 10% threshold.’ 112

105. Ibid., p. 2. 106. Ibid., pp. 1-3 and p. 4 of Appendix A. 107. Ibid., p. 3, p. 4 of Appendix A. 108. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017

and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, op. cit., p. 2; LCA, Submission, Treasury Consultation Paper, Implementing a Diverted Profits Tax, 30 June 2016, pp. 4-5. 109. GHSF, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 6 March 2017, p. 5 110. GHSF, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], submission no. 13, 6 March 2017, incorporating HSF’s submission to the discussion paper (24 June 2016), p. 16; LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 2; LCA, Submission, Treasury consultation paper, implementing a diverted profits tax, May 2016, op. cit., p. 5. 111. Tax Justice Network Australia, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 2. 112. Ibid.

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The sufficient economic substance test Proposed section 177M introduces the sufficient economic substance test. Broadly speaking, proposed section 177M provides that the DPT will not apply in relation to the relevant taxpayer, in relation to a DPT tax benefit, if it is reasonable to conclude that:

• the profit made as a result of the scheme by each entity covered by proposed subsection 177M(2) (the relevant tax payer or an associate that entered into, carried out or is otherwise connected to, the scheme (or any part of it))

• reasonably reflects the economic substance of the entity’s activities in connection with the scheme.

The aim of the sufficient economic substance test is to ensure that the DPT will not apply where there is a commercial transfer of economic activity and functions to another jurisdiction, notwithstanding that jurisdiction has a lower tax rate. 113

Exceptions from the sufficient economic substance test Proposed subsection 177M(3) provides that the sufficient economic substance test does not apply to an entity if the entity’s role in the scheme is ‘minor or ancillary’. However, the Explanatory Memorandum notes that the role of the entity will not be considered minor or ancillary, where:

• an integral part of the scheme involves the fragmentation of functions to different associated entities, with the result that each of those entities are carrying out only a minor part of the scheme, and

• when considered together, the scheme gives rise to combined profits that are not commensurate with the collective activities undertaken.114

The Explanatory Memorandum notes that determining whether an entity’s role in the scheme is minor or ancillary will be a question of fact and degree in each case, but generally, an entity will be considered to have a minor or ancillary role if:

• the entity has no material bearing on the effectiveness or operation of the scheme and

• the entity receives minimal income from the scheme.115

Factors to be considered when applying the sufficient economic substance test Proposed subsection 177M(4) provides that when determining whether the profit made as a result of the scheme by an entity ‘reasonably reflects the economic substance of the entity’s activities in connection with the scheme’ regard must be had to the following matters:

• the functions, assets used and risks assumed by the entity in connection with the scheme to the extent they are relevant116

• the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations as approved by the Council of the OECD and last amended on 23 May 2016117

• and documents issued through or specified by regulations made under paragraph 815-135(2)(b) of the ITAA 1997118 and

• any other relevant matters.119

The Explanatory Memorandum notes that collectively, the above documents provide guidance on how a functional analysis is performed for the purposes of delineating a transaction and ‘also outlines a number of

113. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 36. 114. Ibid., p. 37. 115. Ibid. 116. Proposed paragraph 177M(4)(a). 117. Proposed paragraph 177M(4)(b). 118. Proposed paragraph 177M(4)(b). 119. Proposed paragraph 177M(4)(c).

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other economically relevant characteristics to ensure the functional analysis reflects an accurate delineation of the transaction’.120

Criticisms of the sufficient economic substance test A number of submissions criticised the sufficient economic substance test.

The LCA and MCA both criticised the sufficient economic substance test, with the LCA describing it as being ‘extremely vague’ and the MCA describing it as being ambiguous.121 The LCA and MCA both argued that the use of the phrases such as ‘reasonable to conclude’ and ‘reasonably reflects the economic substance’ leads to imprecision and ambiguity.122

The LCA also noted that the DPT does not, in contrast to the UK’s DPT, contain any focus on the design of the scheme (the UK’s DPT only applies if there is an element of contrivance or artificiality about the scheme). The LCA therefore recommended that an element of contrivance or artificiality should be a necessary element for the DPT to apply. Otherwise, the LCA argued that the DPT would be capable of applying to arrangements that are not intended to be abusive.123

However, it is worth noting that proposed paragraph 177H(1)(b)—in the objects clause—specifies that one of the two primary objects of the DPT is to prevent entities from reducing the amount of Australian tax they pay by diverting profits offshore through ‘contrived arrangements between related parties’. As such, it would appear that as a matter of statutory interpretation proposed section 177M must be considered with that object in mind and hence an element of contrivance should be inferred into the sufficient economic substance test.124

In addition to the above, the LCA argued that two safe harbour provisions should be included in relation to the sufficient economic substance test.

The first of these would be where the non-tax financial benefits exceed the tax benefit. The LCA and Tax Institute both argued that in such circumstances, the arrangement is not abusive and the DPT should not apply.125 The second proposed safe harbour from the sufficient economic substance test would be both a transaction-based test and an entity tax test, modelled on those used in the UK’s DPT.126

The LCA proposed that under the entity test, there should be an exception if more than half of the income is attributable ‘to people functions’, for example if there are significant numbers of employees involved. The LCA argued that this test would provide significant compliance cost savings to taxpayers, and therefore should be included in the Australian DPT.127

Amount of DPT Proposed subsection 177P(1) provides that the amount of diverted profit on which the DPT tax is imposed is:

120. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 38. 121. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 8 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the

Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, pp. 8-9; MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 5. 122. Ibid. 123. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, pp. 8-9. 124. Acts Interpretation Act 1901, section 15AA: ‘In interpreting a provision of an Act, the interpretation that would best achieve the purpose or object of the Act (whether or not that purpose or object is expressly stated in the Act) is to be preferred to each other interpretation’ - in this case, the clearly stated object of the DPT is to prevent entities from reducing the amount of Australian tax they pay by diverting profits offshore through ‘contrived arrangements between related parties’ (proposed paragraph 177H(1)(b)). 125. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 9; Tax Institute, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 1 March 2017, p. 9. 126. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 9. 127. Ibid.

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• if there is one DPT tax benefit in respect of the taxpayer for the relevant income year—the DPT base amount for that DPT tax benefit or

• if there is more than one DPT tax benefit in respect of the taxpayer for the relevant income year—the sum of the DPT base amounts for those DPT tax benefits.

How DPT is calculated Proposed subsection 177P(2) provides two methods for calculating the DPT base amount, and therefore the amount of the DPT tax benefit that the DPT is payable on. These are set out in the table below.

Table 2: how DPT base amount is calculated

Type of DPT tax benefit DPT base amount for a DPT tax

benefit

An amount not being included in the assessable income of the taxpayer where that amount would have been included, or might reasonably be expected to have been included without the scheme

The amount of the DPT tax benefit

A deduction being allowable to the taxpayer where the whole or a part of that deduction would not have been allowable without the scheme The amount of the DPT tax benefit

A capital loss being incurred by the taxpayer where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred without the scheme

The amount of the DPT tax benefit

The taxpayer not being liable to pay withholding tax on an amount where the taxpayer either would have, or might reasonably be expected to have, been liable to pay withholding tax without the scheme

The amount of the DPT tax benefit

Any other type of DPT tax benefit The amount of the DPT tax

benefit divided by the standard corporate tax rate.

Source: proposed subsection 177P(2) of the ITAA 1936, at item 13 of Schedule 1 to the Bill; Income Tax Assessment Act 1936, subsection 177C(1).

DPT Rate Proposed section 177P(1) of the Main Bill and proposed section 4 of the DPT Bill have the effect of imposing a tax rate of 40 per cent on the DPT tax benefit. The Explanatory Memorandum notes that ‘this penalty tax rate has been set to encourage taxpayers to pay the lower corporate tax rate through complying with Australia’s tax rules’.128

Criticisms of the DPT rate and calculation methods GHSF criticised the DPT rate and calculation methods on a number of grounds. First, it was argued that because the DPT is levied on the DPT tax benefit ‘it is likely to overshoot the amount on which tax should be appropriately levied’.129

GHSF noted that two of the common tax benefits that will be subject to the DPT included in the definition of ‘tax benefit’ are:

• an amount not included in assessable income as a result of the scheme or

• an amount claimed as a deduction which would not be deductible but for the scheme.130

HSF noted:

128. Explanatory Memorandum, op. cit., p. 49. 129. GHSF, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., incorporating HSF’s submission to the exposure draft of the Bill (16 December 2016), p. 4.

130. Ibid.

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Frequently in the application of Part IVA aside from the DPT, the ATO will determine that a lesser amount than the tax benefit will be made subject to Part IVA as the real tax saving is reflected in that lesser amount… This approach is supported by an express power in the legislation to make a Part IVA determination in relation to all or part of the tax benefit. Since that power is expressly excluded from the DPT and instead the tax is levied by the legislation directly on the tax benefit, there is no apparent scope for ensuring that the appropriate amount [the real tax saving] is targeted.

131

GHSF also noted that in relation to using the real tax saving as the tax benefit amount ‘the ATO has publicly indicated this particularly in the tax consolidation context, but takes the same approach more generally’.132

In summary, the DPT will tax amounts that could be considered the gross tax benefit, rather than the net or ‘real’ tax saving. Whilst not directly indicated in the Explanatory Memorandum, given that the DPT is designed to act as a penalty tax to ‘encourage taxpayers to pay the lower corporate tax rate through complying with Australia’s tax rules’133 it may be that this is a conscious design feature of the DPT aimed at further increasing the penalty aspect of the tax, independently of the rate.

Assessment and administration The objectives of the administrative arrangements are:

• to secure upfront payment of DPT (‘pay first, dispute later’)

• greater disclosure of information to the ATO to expedite the resolution of disputes and the consequential tax payment (thus ensuring the capture of taxable income that would otherwise have been diverted).134

The key features of the assessment and administrative arrangements are:

• the Commissioner can issue a DPT assessment within seven years of an income tax assessment135

• where the Commissioner makes a DPT assessment, the taxpayer will have 21 days to pay the amount136

• following the issue of the notice of a DPT assessment, the taxpayer will be able to provide the Commissioner with further information disclosing reasons why the DPT assessment should be reduced during the period of review (generally 12 months, unless reduced or extended by interaction between the ATO, the taxpayer or by a Federal Court)137

• at the end of the 12-month review period, based on further information (or because further income tax is assessed or paid, for example due to a taxpayer amending a tax return) one of the following will occur:

- the ATO adhering to its original DPT assessment - the ATO increasing the DPT assessment or - the ATO reducing the DPT assessment138 • at the end of that period of review the taxpayer will have 60 days to appeal to the Federal Court to challenge the assessment or amended assessment139

• in court proceedings the taxpayer will generally be restricted to relying on evidence that the Commissioner had, or was provided to the Commissioner, before the end of the period of review, unless:

- the Commissioner consents to its admission - with leave of the court if the court considers that its admission is necessary in the interests of justice or - the ‘restricted DPT evidence’ is expert evidence that comes into existence after the period of review and is based on evidence that the Commissioner had at any time during the review period.140

131. Ibid., pp. 4-5. 132. GHSF, ‘Diverted profits tax’, GHSF website, 16 February 2017. 133. Explanatory Memorandum, op. cit., p. 49. 134. Explanatory Memorandum, op. cit., p. 4. 135. Proposed section 145-10 of the Taxation Administration Act 1953, at item 44 of Schedule 1 to the Mani Bill. 136. Proposed subsection 177P(3) of the ITAA 1936, at item 13 of Schedule 1 to the Bill. 137. Proposed section 145-15 of the Taxation Administration Act 1953. 138. Explanatory Memorandum, op. cit., p. 55. 139. Proposed subsection 145-20(4) and sections 14ZZ and 14ZZN of the Taxation Administration Act 1953.

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These are discussed below.

The Commissioner can issue a DPT assessment within seven years of an income tax assessment Proposed section 145-10 of the TAA 1953, at item 44 of Schedule 1 to the Bill, provides that the Commissioner can issue a DPT assessment up to seven years after an income tax assessment was issued. This period of time was criticised by a number of interest groups.141 For example, the LCA argued that:

… the proposed 7 year period is objectionable, for three reasons:

(a) it is inconsistent with existing policy;

(b) it is impractical; and

(c) it is unfair to taxpayers. 142

The LCA further noted that a ‘4 year period would be consistent with the existing limitation period that applies to amendments of income tax assessments’ and ‘it is therefore logical that the period for issuing a DPT assessment should also be 4 years’.143

Upfront payment of DPT Proposed subsection 177P(3) of the ITAA 1936, at item 13 of Schedule 1 to the Bill, provides that the DPT Tax is due and payable 21 days after the Commissioner gives the relevant taxpayer notice of the assessment. Proposed sections 177Q and 177R deal with when general interest or shortfall interest charges are payable on DPT Tax amounts.

‘Pay first, dispute later’ Proposed section 145-15 of the TAA 1953, at item 44 of Schedule 1 to the Bill, introduces a 12-month period from the date of a DPT assessment in which the Commissioner can examine the taxpayer’s affairs without the taxpayer being able to object or commence court proceedings to review the assessment—that is, it ensures that the DPT operates on a ‘pay first, dispute later’ basis.

Proposed subsections 145-15(2) and (3) give the taxpayer a power to serve a notice on the Commissioner requiring the period of review to be abbreviated. If such a notice is served, then the Commissioner must apply to the Federal Court for the full 12-month period of review to apply.

Normally, Part IVC of the TAA 1953 provides a taxpayer the right to make a taxation objection against a taxation decision (including an assessment). However, proposed section 145-20 of the TAA 1953 will prevent the taxpayer from making a taxation objection against an assessment of DPT during the period of review. This means that during the review period, there will be no right of objection and no appeal to the AAT—again reinforcing the ‘pay first, dispute later’ aspect of the DPT.

However, proposed paragraph 145-20(4)(c) of the ITAA 1953 provides that the relevant taxpayer will be able to make a taxation objection against an assessment of DPT within 60 days of the end of the period of review. Proposed section 145-20 of the TAA 1953 and item 1 of Schedule 1 (which amends paragraph (e) of Schedule 1

140. Proposed section 145-25 of the Taxation Administration Act 1953. 141. See: LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3, incorporating the LCA’s submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 10; MCA, Submission to Senate

Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 6; GHSF, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., incorporating HSF’s submission to the discussion paper (24 June 2016), pp. 4-5. 142. See: LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill

2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 3, incorporating the LCA’s submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 10. 143. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure

draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 10.

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of the Administrative Decisions (Judicial Review) Act 1977) operate to provide that any such objection may only be made to the Federal Court, not the AAT.

The Government argues that the above approach ‘ensures that the Commissioner is given adequate time to consider information that the relevant taxpayer gives to the Commissioner in the period of review’.144 However, the proposed operation of the review period attracted some criticism. The MCA described the operation of the review and objection arrangements as ‘extremely harsh’ and the LCA argued that:

… the “period of review” procedure provides no advantages and suffers from two disadvantages. First, it lengthens further the period from the original year of income to when a taxpayer and the Commissioner can commence court proceedings, with all the disadvantages attendant on such delay. Second, it appears to be designed to give the Commissioner an opportunity to carry out the review that would ordinarily occur when determining whether or not to allow an objection, but without the flexibility and certainty of the existing regime.

145

Restrictions on taxpayers providing evidence to the court in a dispute Proposed section 145-25 of the TAA 1953 will provide that information or documents that the taxpayer (or an associate) had in its custody or under its control at a time before, during or after the period of review, and that the Commissioner did not have, is inadmissible in evidence in proceedings in the Federal Court related to the DPT assessment (‘restricted DPT evidence’).

The effect of the evidentiary restriction created by proposed section 145-25 of the TAA 1953 is that any information or documents that the taxpayer does not provide to the Commissioner during the period of review for a DPT assessment will generally not be admissible on behalf of the taxpayer in an appeal against the DPT assessment.

However, proposed subsection 145-25(3) of the TAA 1953 allows the evidence to be admitted if:

• the Commissioner consents to its admission

• the Court considers that the admission of the evidence is necessary in the interests of justice or

• the restricted DPT evidence is expert evidence that comes into existence after the period of review and is based on evidence that the Commissioner had in his or her custody or under his or her control at any time in the period of review (that is, it is expert evidence based on information or documents provided to the Commissioner).

The Government argues that the evidentiary restriction ‘will encourage a taxpayer that has been issued a DPT assessment to provide the Commissioner with complete and accurate documents and information, and to make genuine attempts to provide and obtain relevant information, during the period of review’.146

Criticisms of the restricted DPT evidence rules The restricted DPT evidence provisions were criticised on a number of grounds. The LCA argued that it:

… is fundamentally unfair to deny a taxpayer the right to admit evidence that, during the period of review, was outside its custody or control. The definition of “associate” in s 318 of the ITAA 1936 includes partners of a company and holding companies. A taxpayer may have no means of compelling a holding company or a partner to disclose relevant information.

147

144. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 58. 145. MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 6; LCA, Submission to Senate Economics Legislation Committee, Treasury Laws

Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 12. 146. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 59. 147. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 13.

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The LCA further argued that ‘it is particularly unfair’ to prevent a taxpayer from relying upon evidence that only comes into its custody or control or the custody or control of an associate after the period of review expires ‘because the taxpayer and its associates would lack the ability to provide the ATO with that information or documents during the period of review’.148

It would, however, appear that proposed paragraph 145-25(3)(b)—which allows the admission of the evidence if the Court determines it is necessary in the interests of justice—may partly ameliorate this concern. For example, where the taxpayer could prove they attempted to obtain evidence under the control of an associate that they could not compel to provide that evidence to the ATO, and were only able to obtain it after the review period, it would appear at least arguable that in such circumstances the interests of justice would be served by allowing such evidence to be admitted.

The MCA expressed similar concerns to the LCA, noting that whilst:

The MCA understands that an aim of the law is to encourage taxpayers to be cooperative and open with the ATO during an audit or review and to provide information at this time, and while the MCA has sympathy for the need to target taxpayers who are uncooperative with the ATO (Commissioner Jordan outlined legitimate issues with taxpayers dragging their feet on providing information held offshore in Senate estimates hearings in 2016), this restriction of evidence will result in perverse outcomes ...

149

The LCA also argued that the restriction would undermine the purpose of a court hearing—the court’s rules of evidence are ‘designed to ensure that the judge has available all relevant information and documents and that those documents and information are of a high quality’ and the restriction would prevent that from happening.150 The LCA expressed concern that the restricted evidence rules would:

• create a ‘perverse incentive’ for taxpayers to provide every single piece of potentially relevant evidence to the Commissioner during the review period, to ensure that they would not be disentitled from relying on evidence that becomes relevant in a court hearing (the ‘kitchen sink approach’)

• disadvantage the Commissioner if, for example ‘he came into possession of documents or information which would assist his case, and that the taxpayer or its associates had in their custody or control but which they failed to provide to the Commissioner’.151

Key issues and provisions—Schedule 2 As the Explanatory Memorandum contains a sufficient explanation of the changes proposed by Schedule 2 of the Bill, only a summary is provided below.

Schedule 2 of the Bill increases penalties for ‘significant global entities’ (SGEs) that breach their tax reporting obligations (including lodging tax documents on time and taking reasonable care when making statements) by amending Schedule 1 to the TAA 1953.152 Schedule 2 of the Bill also includes a minor technical amendment to the TAA 1953 to ensure administrative penalties apply where a SGE does not lodge a general purpose financial statement as required under the taxation law.

Breaches of these obligations result in what are referred to as ‘failure to lodge’ (FTL) penalties. The FTL penalty is an administrative penalty applied to entities that do not lodge a return, notice, statement or other approved form with the Commissioner by the required day.153 The penalty is intended to encourage the timely lodgement of taxation documents.

148. Ibid. 149. MCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 6. 150. LCA, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017

and Diverted Profits Tax Bill 2017 [provisions], 2 March 2017, p. 3 incorporating the LCA’s, submission to Treasury regarding the exposure draft of the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017, 22 December 2016, p. 13. 151. Ibid., p. 14. 152. Taxation Administration Act 1953. 153. Taxation Administration Act 1953, subsection 286-75(1).

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The amount of the penalty is worked out under section 286-80 of the TAA 1953, which provides for a base amount of one penalty unit (currently $180) for each period of 28 days that the lodgement of the document is overdue up to a maximum of five periods, limiting the maximum penalty to $900.154

The base penalty is multiplied by various amounts, depending on whether the entity meets certain thresholds (subsections 286-80(3) and (4) require assessment of the entity’s assessable income, GST turnover or status as a medium or large withholder for a particular period) resulting in the following:

• the base penalty is multiplied by two if the entity meets certain threshold criteria for a ‘medium entity’155

• the base penalty is multiplied by five if the entity meets certain threshold criteria for a ‘large entity’.156

This results in a maximum penalty of $4,500 for a ‘large entity’. This penalty amount applies to all entities with assessable income of $20 million or more in the relevant year. This means that the maximum penalty applies equally to entities with $20 million (or more) of assessable income as well as to those entities with $1 billion (or more) of assessable income.

The Government argues that these ‘existing penalties may not be an effective deterrent for non-compliance by [significant global] entities given the significant financial resources that large entities have at their disposal’157 and hence proposed section 286-80(4A) of the TAA 1953, at item 6 of Schedule 2 to the Bill, will introduce a new multiplier of 500 times the base amount for SGEs.

Importantly, the amendments provide that the new multiplier of 500 applies to the exclusion of any multipliers that may also apply to an entity that is both a SGE at the relevant time and an entity meeting criteria in subsections 286-80(3) or (4) as a medium or large entity. In other words, the increased FTL penalties will apply uniformly to all SGEs, regardless of their size.158

The table below set out the proposed FTL penalties. Penalties marked with an asterisk (*) are unchanged.

Table 3: proposed FTL penalties

Days late 28 or less 29 to 56 57 to 84 85 to 112 More

than 112

General case

(provided entity is not a significant global entity at the relevant time)

(Multiplier 1)

$180* $360* $540* $720* $900*

Medium entity meeting threshold criteria in subsection 286-80(3) (provided entity is not a significant global entity at the relevant time)

(Multiplier 2)

$360* $720* $1,080* $1,440* $1,800*

Large entity meeting threshold criteria in subsection 286-80(4) (provided entity is not a significant global entity at the relevant time)

(Multiplier 5)

$900*

$1,800* $2,700*

$3,600* $4,500*

154. The amount of a penalty unit is specified at section 4AA of the Crimes Act 1914 (Cth). 155. Taxation Administration Act 1953, subsection 286-80(3). 156. Ibid., subsection 286-80(4). 157. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017,

p. 68.

158. Ibid., p. 76.

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Days late 28 or less 29 to 56 57 to 84 85 to 112 More

than 112

Significant global entity

(Multiplier 500)

$90,000

$180,000 $270,000

$360,000 $450,000

Source: Section 286-80 and proposed subsection 286-80(4)A of Schedule 1 of the TAA 1953.

In its report on the Bill, the Senate Economics Legislation Committee noted that the increased penalties for SGEs attracted relatively few submissions. However, the following was noted:

• the CTA and G100 considered that the proposed 100 fold penalty increase for SGEs should be limited to MNCs that opt out of their reporting obligations

• AFMA was concerned about the discretion given to the Commissioner regarding the remission of FTL penalties

• the Tax Justice Network-Australia was supportive of ensuring that the penalties are adequate to remove the profit from the crime and

• some submissions argued that the increase in penalties should only apply to documents relevant to tax affairs, not those which assist the efficient operation of the tax system.159

The Senate Economics Legislation Committee concluded that despite the above concerns:

No matter how large or important a business is, there can be no excuse for inaccurate or delayed tax reporting and administration by large multinationals. 160

Key issues and provisions—Schedule 3 Schedule 3 of the Main Bill amends the ITAA 1997 to give effect to the OECD’s recommendations regarding transfer pricing.161

Transfer pricing rules are integrity rules designed to ensure that jurisdictions receive an appropriate share of tax from multinational firms, based on commonly agreed criteria. In summary, Australia’s transfer pricing rules require an entity entering into a cross-border transaction to value that transaction according to the ‘arm’s length conditions’ and ‘arm’s length profits’ that might be expected to exist between independent entities that deal wholly independently with one another in comparable circumstances.162

Arm’s length conditions and arm’s length profits are required to be identified consistently with certain guidance material. Currently this guidance material includes the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as approved by the Council of the OECD and last amended on 22 July 2010 (2010 OECD Guidelines).

As part of the G20/OECD BEPS Project, it was acknowledged that the existing international standards for transfer pricing rules could be misapplied so that they resulted in outcomes in which the allocation of profits was not aligned with the economic activity. As a result, new Transfer Pricing Guidelines were produced.163

Proposed paragraph 815-135(2)(aa) of the ITAA 1997, at item 2, along with items 1, 3 and 4 of Schedule 3 of the Main Bill will ensure that the most recent OCECD Transfer Pricing Guidelines—‘Aligning Transfer Pricing Outcomes with Value Creation’—can be used when applying the transfer pricing rules in the ITAA 1997 from 1 July 2016 onwards.

159. Senate Economics Legislation Committee, Report into Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., pp. 20-21. 160. Ibid., p. 22. 161. Income Tax Assessment Act 1997. 162. The Treasury, Income Tax: cross border profit allocation - review of transfer pricing rules, consultation paper, Treasury, Canberra, 2 November

2011, p. iv. 163. Explanatory Memorandum, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017, p. 83-84.

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Criticisms of the transfer pricing guidelines A number of submissions questioned the ability for existing transfer pricing rules to effectively deal with related party transactions between MNCs. For example, KPMG, whilst supporting the adoption of the new OECD transfer pricing guidelines, noted:

At the root of this problem is that the very nature of a successful MNE is it is not acting as disparate arm’s length parties do. Synergies arise from the co-ordinated activities of a MNE, which present a residual profit that would not arise for disparate parties acting at arm’s length. 164

Tax Justice Network Australia made a similar observation about the inapplicability of the ‘arms-length’ principle to the economic reality of MNCs, but went further in its recommendation than KPMG:

The only effective way to end many of the tax cheating strategies of multinational enterprises is to abandon the arm’s length principle for transfer pricing and treat multinational enterprises in accordance with the economic reality that they operate as unitary firms. By continuing to accept the fiction that a multinational enterprise is a group of separate entities transacting with each other the OECD BEPS project failed to deliver on the G20 request to reform the rules so that multinational enterprises could be taxed ‘where economic activities occur and value is created’. While enacting the DPT, Australia should press for such a new approach in the BEPS project, as part of the continuing work on the profit split method, and in the Digital Economy Task Force.

165

Chartered Accountants Australia and New Zealand (CAANZ) argued that the 1 July 2016 date of application of the new OECD transfer pricing guidelines was retrospective.166 The Senate Economics Legislation Committee argued that ‘given that the recommendations were released in 2015’ the application date from 1 July 2016 ‘is appropriate and should be maintained.’167

Concluding comments Whilst modelled off the UK’s DPT, the DPT proposed by the Bill differs in a number of ways. When viewed as a whole, it would appear that the Australian DPT is aimed more at changing the behaviour MNCs, improving information disclosure and providing the ATO with flexible enforcement options than raising new revenue. In other words, it appears to be more a deterrent tool than a revenue raising tool.

164. KPMG, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 6-7. 165. Tax Justice Network Australia, Submission to Senate Economics Legislation Committee, Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit. pp. 1-2. 166. Chartered Accountants Australia and New Zealand (CAANZ), Submission to Senate Economics Legislation Committee, Treasury Laws

Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], 6 March 2017, p. 6. 167. Senate Economics Legislation Committee, Report into Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 and Diverted Profits Tax Bill 2017 [provisions], op. cit., p. 22.

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