Revenue measures for the Federal Budget – what levers can the Government pull?

Multinational tax integrity

As we quickly move towards the new Government’s first budget, questions are raised around what revenue measures could be introduced to assist with budget deficit repair. A simple increase in tax rates will not suffice, especially given the recent commentary around supporting the planned rate reductions. What is more likely is increased focus on multinationals and implementing measures seeking to increase the level of Australian tax collected as a result of their activities.

It’s important to note this narrative is not one peculiar to Australia – as we continue to operate in a global economy, the challenge of all countries has been to ensure an appropriate amount of tax revenue is collected within their borders.

The OECD has, in recent years, been gathering momentum towards addressing perceived tax avoidance amongst multinational enterprises (MNEs), ensuring a fairer distribution of tax for all taxpayers. The Government’s proposed multinational tax integrity measures is consistent with that shift.

They were first announced as part of their election promises, with the intent of addressing the “loopholes” available to MNEs in the Australian taxation system. In short, the Government will look to rewrite certain tax laws as they apply to MNEs.

The Government has forecast these measures to raise $1.89 billion over the forward estimates (source: ALP website), which in turn they assert will support their Budget and fund essential projects for the Australian community.

The issues highlighted to justify the introduction of these measures include the shifting profits to low or no-tax jurisdictions to avoid paying tax in countries like Australia, particularly through the use of intangible assets, as well as MNEs artificially inflating the cost of debt they hold in Australia to claim higher deductions, which can reduce the amount of tax paid in Australia.

The measures that the Government will be supporting to address the issue of tax avoidance include the following:

1. Supporting the OECD Two-Pillar approach for a global 15 per cent minimum tax.
2. Limiting debt-related deductions by MNEs at 30 per cent of profits, which is consistent with the OECD approach.
3. Limiting the ability of MNEs to hold intellectual property in tax havens.
4. Introducing transparency measures that include enhanced reporting requirements, beneficial ownership, and tax haven exposure.

Items 2-4 were outlined in detail in Treasury’s Discussion Paper released on 5 August 2022 for public consultation.

Supporting the OECD Two-Pillar approach

The OECD global Two Pillar approach is aimed at addressing challenges created by the digitisation of the economy, and includes:

• a global minimum effective tax rate of 15 per cent ensure multinationals pay an appropriate share on the profits they make around globally; and
• a more equitable distribution of profits by MNEs, particularly those with digital profits.

The Government has pledged to join the OECD members in implementing these measures, which will not begin before at least 2023.

Limiting debt-related deductions by MNEs

The proposals will adapt the existing thin capitalisation rules to align with the OECD’s recommendation under Action 4 of the Base Erosion and Profit Shifting (BEPS) program, by replacing the current safe harbour debt test with a fixed ratio rule limiting net interest deductions to 30 per cent of EBITDA.

The policy intent of being based on earnings is to ensure interest deductions are directly linked to economic activity and taxable income. This is compared to the current assets-based test which has the potential to be utilised in tax planning strategies to shift profits out of Australia.

In bringing forward this recommendation, the Discussion Paper draws comparisons to other countries that have adopted similar approaches, including the US, UK, Germany, Japan, Sweden, Norway and Spain.

Limiting Deductions Related to Intangible and Royalty Payments

There has been a noticeable increase in MNEs directing payments into lower or no tax jurisdictions, particularly when there is intellectual property being held. Although Australia does have existing rules that in part address these issues, such as transfer pricing rules, general anti-avoidance provisions, and controlled foreign company rules, the proposals introduce more targeted integrity rules. As such, there would be a limitation to the deductions allowed for intangibles and royalties paid to low or no-tax jurisdictions, or those that lead to insufficient tax being paid outside of Australia.

The Discussion Paper introduced several potential scenarios to identify low or no-tax jurisdictions, including taking concepts from the hybrid mismatch targeted integrity rule, the Global Anti-Base Erosion Rules minimum tax rate, the sufficient foreign tax test, identifying intellectual property tax-preferential regimes, and developing low or nominal tax jurisdiction lists.

The Australian Taxation Office (ATO) has identified deductions relating to intangibles and royalties as an area of interest in the past, with the proposals outlined in the Discussion Paper targeted to capturing profit shifting utilising these methods. It was also noted in the Discussion Paper the proposals are consistent with those in other OECD jurisdictions.

Enhanced Tax Transparency

The proposal will safeguard enhanced tax transparency through public reporting of high-level tax information on a country-by-country basis, mandatory reporting of material tax risks to shareholders, and requiring those tendering for Australian government contracts to disclose their country of tax domicile. The policy intent of this is to increase transparency for the market and investors.

Budget night announcements?

The Discussion Paper did not include details of how the measures would apply, nor specify a commencement date for each of the proposals, although this may be as early as 1 July 2023.

Consultation for these measures closed 2 September 2022, and we anticipate these measures will be formally announced as part of the October 2022 Federal Budget, with increased certainty around commencement date, application, and any transitional provisions.
Of note is that our current corporate tax rate is higher than many of our trading partners, so it could be argued while this approach is being championed by the OECD and many other nations, the impact on MNEs in Australia may be somewhat stronger.

What is certain is that any MNEs operating in Australia will need to review their business models to account for these proposed changes and prepare themselves for even greater public scrutiny.

It will be interesting to see whether these further changes negatively impact on the number MNEs operating in Australia, and foreign investment decisions into Australia. The Government has a challenge in ensuring the integrity of our tax system, while at the same time supporting commercial development in the Australian economy. The effect of a post-COVID world has not made this challenge any easier.