Denial of tax deductions: cross border payments for intangibles

These measures were previously announced as part of the Government’s multinational tax integrity package, and subject to a Treasury Consultation paper in August of last year. Public consultation in respect of the draft legislation is open until 28 April 2023.

Key aspects of the draft provisions are as follows:

1. The measures apply to Australian entities that are part of an SGE group, i.e. with global revenue of more than AUD$1bn.
   
   
2. The measures will deny deductions where an SGE makes a payment to an associate that is attributable to a right or permission to exploit an intangible asset, and as a result of that or a related arrangement, income from the exploitation of those or related intangible assets is directly or indirectly derived by an associate of the SGE in a low corporate tax jurisdiction.
   
   
3. The measures define the term “intangible asset” to take its “ordinary” meaning at law which covers a very wide range of assets. The measures provide some specific examples of intangibles such as intellectual property, copyright, access to customer databases, algorithms, software licences, licences, trademarks or patents.
   
   
4. The meaning of the term to “exploit” is also widely drafted. Examples include the use of, marketing, selling and distributing the intangible asset. The definition extends to “mere permission” to exploit, to capture arrangements beyond legally enforceable rights, so therefore may include implicit rights or understandings between related parties.
   
   
5. The measures seek to capture payments that may be mischaracterised to disguise the true nature of what is being paid for. For example, they may apply where a contract provides that a payment is made for “other things”, such as services or tangible goods, but where the arrangement in substance also results in the associate exploiting, or acquiring a right to exploit, an intangible asset even where no cost or price is specified for that use. This is in line with previous ATO rulings on so called “embedded royalties”.
   
   
6. The Government may apply a specific shortfall penalty provision (in addition to the existing penalties for SGEs and under the general anti-avoidance rules) as a punitive measure to penalise SGEs who mischaracterise such payments in an attempt to avoid income tax, including withholding tax.
   
   
7. These measures will require SGE taxpayers to undertake complex analysis to apportion payments between the use of intangibles and other matters.
   
   
8. The measures focus on payments to low corporate tax jurisdictions i.e. where the lowest corporate income tax rate under the laws of that jurisdiction applicable to an SGE is less than 15 per cent or nil. In determining what the relevant corporate income tax rate is, deductions, offsets, tax credits, tax losses, tax treaties, concessions for intra-group dividends and tax rates that only apply to foreign residents are disregarded. Only national or federal (i.e. excluding state or territory) corporate tax is relevant for determining whether a foreign country is a low corporate tax jurisdiction.
   
   
9. The measures will also apply to deny deductions for payments to associates where income from exploiting the intangible asset is derived in a jurisdiction determined by the Minister as providing for a preferential patent box regime without sufficient economic substance in that jurisdiction.

These measures are very wide reaching and will possibly require SGE taxpayers to undertake complex analysis to trace and apportion payments to determine if they are subject to these measures. Impacted Australian SGEs should consider the potential impact of the proposed measures well before their proposed application from 1 July 2023.

Please contact your Grant Thornton adviser if you wish to discuss these matters further.