Australian Treasury denies SGEs deductions for payment relating to intangibles
Exposure Draft Bill released by Australian Treasury denying SGEs deductions for payments attributed to intangible assets in low tax jurisdictions.
The Exposure Draft Bill (the draft Bill), released on 31 March 2023, proposes a new anti-avoidance rule to deny deductions for payments attributed to intangible assets located in low corporate tax jurisdictions. Significantly, the changes do not remove withholding tax from affected payments that are classed as royalties. In some circumstances, payments may therefore be both non-deductible, and subject to Australian withholding tax at rates of up to 30%.
The changes will apply to payments made by significant global entities (SGEs) on or after 1 July 2023. Broadly, SGEs are members of multinational groups with annual consolidated global income of at least AUD 1 billion. The proposed 1 July 2023 start date allows little time to prepare for the impact of the proposed changes.
The draft Bill is one of several measures introduced in the 2022-23 Federal Budget as part of a comprehensive strategy to enhance multinational enterprises’ tax integrity.
Anti-avoidance rule changes
The statutory objective is to discourage SGEs from avoiding income tax by channeling income from the exploitation of intangible assets to low corporate tax jurisdictions. The proposed rule will apply to payments:
- made by SGEs
- in relation to an arrangement where the SGE or an associate acquires or exploits the intangible asset
- where the arrangement results in the recipient (or another associate) generating income in a jurisdiction with low taxes.
A jurisdiction will be classed as a ‘low corporate tax jurisdiction’ if the corporate tax rate is less than 15%.
The rules are also intended to encompass the incurring of a liability or crediting of an amount, without an actual direct royalty payment. This ensures the proposed rules cannot be evaded through indirect payments.
Intangible assets payments
As expected, the proposed law applies to relevant payments made by an SGE directly or indirectly to an associate.
Payments made directly to unrelated third parties are not within the scope of the proposed law unless they are otherwise also indirect payments to an associate.
General definition of intangible assets
In general, the term ‘intangible asset’ is interpreted according to its ordinary meaning. However, the draft Bill proposes an additional definition.
The proposed rules will utilise some of the existing definitions of ‘royalty’ in the current tax legislation, with respect to the use or supply of specific assets. Some examples are:
- intellectual property rights such as trademarks, patents, designs and processes
- knowledge and information pertaining to certain fields such as science, technical and commercial
- in house designed algorithms
- any tapes, visual images or sounds used for broadcasting
- motion picture films.
The proposed definition of intangible asset also encompasses rights or interests in the type of assets mentioned above. Additionally, further assets may be specified in the regulations.
The proposed rule does not extend to rights related to tangible assets, such as interests in land, or to financial arrangements (as defined in the existing tax legislation). The exclusion from categorisation as intangible assets equally applies to industrial, commercial, or scientific equipment.
The phrase, ‘to the extent’ in the proposed law contemplates payments of an undissected amount for a bundle of rights or benefits. Apportionment may then be required to allocate part of the payment as relating to the intangible assets. The deduction for that portion of the payment would then be denied.
Several transfer pricing methodologies may be used to apportion payments, however the proposed law is yet to provide guidance on how such apportionment should occur. This appears similar to the potential uncertainty on apportionment of income received in respect of software (albeit relevant to withholding tax).
Low corporate tax jurisdictions
The draft Bill defines a ‘low corporate tax jurisdiction’ as a country in which the lowest corporate income tax rate applicable to an SGE is below 15%. Determining the ‘lowest corporate income tax rate’ of a country may be a complex matter.
Of concern is the fact that jurisdictions which provide tax exemptions for specific types of income may be classed as low tax jurisdictions due to the broad scope of this definition. A country such as New Zealand, which does not generally tax capital gains, may be classed as a low corporate tax jurisdiction.
A Government Minister can also determine that a jurisdiction qualifies as low tax if it has a preferential patent box regime. This provision is only intended to capture patent box regimes that provide concessional tax treatment without requiring any economic activity to develop the relevant intellectual property in the country providing the patent box treatment.
In making a determination, the Minister may have regard to publications of the Organisation for Economic Co-operation and Development (OECD).
The suggested tax threshold aligns with the global trend towards a domestic minimum tax (DMT) rate of 15% as proposed under the OECD’s Global Anti-Base Erosion (GloBE) Pillar Two initiative. Nonetheless, it exceeds the existing minimum royalty withholding rate of 10% commonly found in Australia’s double taxation agreements. Furthermore, the proposed rate is higher than the 10% rate stipulated in the equivalent legislation of the United Kingdom.
Exploitation of intangible assets
The draft Bill introduces an innovative concept in defining intangible assets to be ‘exploited’. This concept encompasses a wide range of arrangements that go beyond the mere use of the asset. Examples include the use by way of marketing, selling, licensing, distributing, supplying, or engaging in any other activity with the intangible asset. This expanded definition of ‘exploitation’ aims to cover a broad spectrum of arrangements, highlighting the comprehensive scope of activities that may be captured.
The condition will also be deemed as fulfilled if the SGE is granted explicit authorisation to utilise the intangible asset. According to the draft Explanatory Materials, as long as there is a mutual understanding between the parties that allows the SGE to access and utilise the intangible asset, this requirement will be considered met. It should be noted that this condition can still be satisfied even if the permission is not explicitly documented.
The broad definition of ‘exploit’ implies that the threshold for meeting this requirement is relatively low, which means that even ordinary commercial arrangements could potentially fall within its scope. Taxpayers will need to carefully assess the application of the other conditions to determine if the provisions are applicable in their specific situation.
The Government is also requesting stakeholder views regarding the appropriateness of a shortfall penalty provision to be imposed on SGEs which mischaracterise payments in an attempt to avoid income tax, including withholding tax. Given the onerous penalty regime that already applies to SGEs, the introduction of further specific penalties under the intangible payments rules would seem to be excessive.
How SW can help
Our tax experts can assist with
- analysing arrangements referrable to the use of intellectual property and the likelihood of the measures applying to denied deductions
- analysing the substance of payments, including the extent of apportionment required to determine the part attributable to a right to exploit an intangible asset
- assessing the extent of income from exploiting intangible assets that is derived in a low corporate tax jurisdiction.
SW will be monitoring announcements and will keep you updated as more information becomes available.
Please reach out to the Key Contacts here or your SW contact if you would like assistance determining the impact of the measures on your group, and advice on how your group can navigate the complexities.