While the ruling sets out the ATO’s interpretation of the law, the draft Practical Compliance Guideline is arguably the more important document for many taxpayers because it provides a roadmap for understanding how the ATO intends to allocate its compliance resources. In simple terms, taxpayers can self-assess their arrangements into a risk zone ranging from white (lowest compliance risk) to red (highest compliance risk).

For CFOs, financial controllers, and technology businesses, the key question is often not whether software payments exist, but whether the ATO might consider part of those payments to be royalties that should be subject to royalty withholding tax. The new framework is intended to provide greater certainty around that issue.

Why has the ATO released this guidance?

The framework follows the High Court’s decision in PepsiCo and reflects the ATO’s view that economic substance and examining the totality of the arrangement may be relevant in identifying an embedded royalty, even where no royalty is expressly stated in the contract.

The guidance currently applies to software intermediation and distribution arrangements, with further schedules expected for other industries and transaction types.

Understanding the risk zones

Particular focus on restructures

The draft guidance includes a clear ATO warning on restructures.

The ATO may review changes to contractual or operating structures that reduce or eliminate Australian royalty withholding tax, even where the arrangement otherwise falls within a lower-risk zone. Transfer pricing, MAAL, DPT, and Part IVA may also be relevant.

Multinational groups undertaking software licensing or distribution restructures should therefore consider royalty withholding tax alongside transfer pricing.

Amber Zone example

A foreign software provider licenses ERP software to AU Software Co, an Australian related-party distributor, for supply to Australian customers. The agreement with the software owner grants AU Software Co the exclusive right to market and distribute the ERP software to Australian customers. However, it does not grant AU Software Co the right to make copies of, or modify, the ERP software. AU Software Co enters into customer contracts and receives payments from those customers, while the offshore supplier owns the software and provides the underlying platform and support. AU Software Co does not recognise any part of its payment to the offshore supplier as a royalty for Australian tax purposes.

On the facts in Example 8, the ATO would treat the arrangement as falling within the amber zone. The key risk indicators are that the Australian distributor is selling software-related products or services to Australian customers, the software and associated intellectual property are held offshore, and no Australian royalty has been recognised or subjected to royalty withholding tax.

The example illustrates that, where the relevant software rights and economic value sit offshore but Australian customer-facing activities are carried on locally, the ATO may expect taxpayers to undertake and document a more detailed royalty risk assessment.

By contrast, the risk assessment changes to the red zone where AU Software Co is also granted rights to make copies of, or modify, the ERP software. A red zone outcome may also arise where the software owner is located in a specified jurisdiction, or, generally speaking, is otherwise shielded from tax on the relevant income.

How SW can help

Businesses with cross-border software, SaaS, platform or technology distribution arrangements should review their existing arrangements against the framework. Even where no royalty has historically been recognised, the ATO expects taxpayers to be able to explain and support that position.

SW can assist in the following assessment:

• assessing where your arrangement is likely to sit within the ATO’s risk framework
• whether the undissected payments contain a royalty component
• whether sufficient documentation exists to support your position
• identifying whether practical steps are available to mitigate the relevant royalty withholding tax risk.

The release of TR 2026/2 and PCG 2026/D4 signals that software royalty arrangements will remain an area of significant ATO focus. Early assessment of risk positions and supporting documentation may help reduce the likelihood of future disputes and compliance costs.

The post What the ATO’s finalised software royalties ruling & draft guidance means for businesses appeared first on SW Accountants & Advisors.

Year 2 is different.

For groups with a 31 December 2025 year end, the first substantive Pillar Two returns will generally be due by 31 March 2027, being 15 months after year end. Accordingly, MNE groups should already be considering their year 2 compliance strategy and data requirements.

The ‘no charging mechanism’ position no longer applies

One of the unique features of the first year of Pillar Two compliance was that many jurisdictions were not yet subject to any qualifying charging mechanism, being the Income Inclusion Rule (IIR), Domestic Minimum Tax (DMT) or Undertaxed Profits Rule (UTPR).

As a result, for the year ended 31 December 2024, some jurisdictions could effectively be excluded from substantive Pillar Two consideration because no jurisdiction had a charging mechanism to impose top-up tax in relation to those jurisdictions.

For the fiscal year ended 31 December 2025, this position changes significantly.

From fiscal years beginning on or after 1 January 2025, Australia’s UTPR commences. At the same time, many jurisdictions that did not previously apply an IIR or DMT have now introduced one or both charging mechanisms.

Consequently, jurisdictions that attracted limited Pillar Two attention during year 1 may now require a more detailed assessment. Finance teams should avoid assuming that conclusions reached during the 2024 compliance cycle remain valid for 2025.

More jurisdictions will require safe harbour analysis

For many groups, the 2024 exercise focused only on (a limited number of) jurisdictions where a charging mechanism existed and therefore where a potential top-up tax exposure could arise.

For 2025, safe harbour analysis may need to be performed for jurisdictions that did not require assessment in the prior year because no charging mechanism applied.

Where a jurisdiction satisfies one of the Transitional CbCR Safe Harbour tests, no full Pillar Two calculation will generally be required for that jurisdiction.

However, where none of the available safe harbour tests are satisfied, the MNE group may be required to undertake full GloBE calculations for that jurisdiction.

Accordingly, even where the underlying business has not changed materially, the number of jurisdictions requiring analysis may increase significantly from year 1 to year 2.

The transitional CbCR safe harbour ‘once-out, always-out’ rule becomes more relevant

As groups move into their second year of compliance, greater attention should be given to the operation of the TCSH rules.

Broadly, where a jurisdiction ceases to qualify for the TCSH for one year, that jurisdiction is unable to subsequently re-enter the safe harbour regime in a later year.

This ‘once-out, always-out’ concept means that safe harbour assessments should be undertaken carefully and supported with appropriate documentation.

The year 2 assessment therefore should not simply be viewed as a rollover of the year 1 position.

Jurisdictions not assessed in 2024 should not automatically lose access to TCSH

A practical issue likely to arise for many MNE groups concerns jurisdictions that were not required to be analysed in 2024 because no charging mechanism applied.

In our view, the fact that a jurisdiction was not required to consider the TCSH in 2024 should not, by itself, prevent that jurisdiction from relying on the TCSH when a charging mechanism first becomes applicable in 2025.

This situation should be distinguished from a jurisdiction that was assessed in 2024 and failed the TCSH requirements.

In other words, the fact that the TCSH was not relevant to a particular jurisdiction in year 1 should not necessarily preclude that jurisdiction from accessing the TCSH in year 2 when a charging mechanism becomes applicable.

Given the potential compliance savings that can arise from the TCSH, this distinction may be important for many MNE groups.

Group restructures may create additional Pillar Two compliance obligations

MNE groups that undertake restructures during the year should carefully consider the Pillar Two implications, even where the restructure appears relatively straightforward.

In particular, changes involving the identity of the Ultimate Parent Entity (UPE), the insertion of a new holding company, mergers, demergers, acquisitions, disposals, or changes to ownership chains can give rise to additional Pillar Two compliance requirements. In some cases, a single accounting period may involve multiple reporting obligations, separate filing positions, or different safe harbour assessments before and after the restructure.

Importantly, transactions that may appear routine from a legal or commercial perspective can have consequences for Pillar Two group composition, filing obligations, and the application of safe harbours. Accordingly, MNE groups should consider reviewing any restructuring activity undertaken during the year to determine whether it affects their Pillar Two compliance position, reporting obligations or filing approach. Early identification of these issues can help avoid unexpected compliance obligations and reduce the risk of errors when lodgement deadlines approach.

Governance & readiness remain critical

While many MNE groups may continue to benefit from the TCSH for the year ended 31 December 2025, this relief is temporary. Accordingly, organisations should use the transitional period to prepare for the point at which full GloBE calculations are required.

In our experience, groups that use the transitional years to enhance data collection processes, identify information gaps, and establish governance frameworks will be significantly better positioned when safe harbours cease to be available.

Management should therefore consider:

• whether the group currently captures all data that may be required to perform full GloBE calculations in future years
• whether roles and responsibilities between tax, finance, and accounting teams remain appropriate
• whether assumptions adopted during year 1 remain valid
• whether local advisors are required in newly implementing jurisdictions
• whether documentation supporting safe harbour positions is being maintained
• whether reporting to senior management and audit committees remains fit for purpose.

Revenue authorities around the world are increasingly focused on Pillar Two implementation, and MNE groups should expect greater scrutiny as the first substantive returns begin to be lodged. MNE groups that invest in preparing for full calculations during the transition period are likely to experience a more efficient and lower-risk compliance process when the TCSH is no longer available.

Don’t forget the tax provision process

For many MNE groups, Pillar Two was initially viewed as a future compliance exercise.

As year 2 approaches, Pillar Two considerations are becoming increasingly relevant to the annual tax reporting cycle. Finance teams should consider whether any Pillar Two developments may affect tax accounting positions, disclosures, governance processes, and audit discussions.

Early engagement between tax teams, finance teams, and auditors will generally result in a more efficient compliance process.

Looking ahead

The year ended 31 December 2024 was largely about understanding the new rules and determining whether transitional relief was available.

The year ended 31 December 2025 represents the next phase of the regime.
The commencement of Australia’s UTPR, the broader rollout of IIR and DMT regimes globally, and the need to assess additional jurisdictions under the Transitional CbCR Safe Harbour rules mean that many MNE groups will find year 2 materially different from year 1.

For MNE groups with a 31 December 2025 year end, the Pillar Two lodgement deadline is 31 March 2027. While this may appear some time away, experience suggests that MNE groups that commence planning early are better positioned to manage data collection, governance requirements, and filing obligations efficiently.

How SW can help

SW’s Pillar Two specialists can assist with:

• transitional CbCR Safe Harbour assessments
• review of year 1 positions and implications for year 2
• jurisdictional charging mechanism analysis
• governance frameworks and documentation for Pillar Two
• preparation and review of GloBE calculations
• lodgement obligations for Australian Pillar Two.

If you would like to discuss the implications of year 2 Pillar Two compliance for your group, please contact your usual SW advisor.

Contributors

Antony Cheung | Associate Director, Tax

The post Pillar Two in year 2 & what’s different from year 1 appeared first on SW Accountants & Advisors.

The draft guidance may affect crypto asset businesses, investors, and other Australian resident taxpayers. Importantly, wrapping or unwrapping a crypto asset may trigger a taxable event even where the taxpayer retains substantially equivalent economic exposure.

Airdrop arrangements

An airdrop generally involves an issuer distributing established or newly created crypto assets to a recipient. Airdrops may be used to reward the holder of another digital asset, promote a project, remunerate services, or distribute assets without the recipient’s prior knowledge.

TR 2026/D1 addresses the income tax consequences for Australian resident issuers and recipients. It does not apply where crypto assets are transferred in exchange for money or other crypto assets. The proposed treatment depends on the circumstances in which the airdrop occurs.

Crypto asset trading businesses

• Crypto assets held in the ordinary course of a crypto asset trading business may be trading stock.
• An issuer may be entitled to deduct expenditure incurred in providing an airdrop where the general deduction requirements are satisfied.
• A recipient may need to include the value of an airdropped crypto asset in assessable income.

Rewards, hobbies & other airdrops

Where a recipient receives crypto assets as a reward for services, promotional activity, or another income-producing activity, the market value of the assets when derived may be assessable as ordinary income. That value will also be relevant when determining the asset’s cost base or trading stock value for subsequent tax purposes.

An airdrop received in the course of a genuine hobby or recreational activity may not be ordinary income. However, the subsequent disposal of the asset may still have CGT consequences. Whether an activity is a business, income-producing activity, or a hobby depends on the particular facts.

Wrapping & unwrapping crypto assets

A wrapping contract is a smart contract that exchanges a crypto asset for a wrapped equivalent, usually so that it can operate on a particular protocol or platform that it would otherwise not be compatible with.

Under TD 2026/D2, the ATO’s preliminary view is that a taxpayer ceases to own the original crypto asset when it is transferred to the wrapping contract and instead receives a separate CGT asset in the form of the wrapped crypto asset. The ATO’s reasoning is as follows:

• CGT event C2 happens when the taxpayer’s ownership of the original crypto asset ends.
• The capital proceeds are generally the market value of the wrapped crypto asset received.
• The taxpayer compares those proceeds with the cost base of the original asset to calculate any capital gain or loss.
• Unwrapping may trigger a further CGT event when ownership of the wrapped asset ends and the original token is received.

This means wrapping and unwrapping may each create a tax liability despite the taxpayer maintaining broadly equivalent economic exposure before and after the transaction. The draft Determination applies only to the arrangements described in it. Other smart contracts and cross-chain arrangements may have different legal and tax consequences.

Alternative views

TD 2026/D2 acknowledges alternative views, including that the taxpayer may retain a continuing property interest in the original crypto asset or that another CGT event may be more appropriate. The ATO nevertheless concludes that CGT event C2 applies to the arrangements covered by the draft Determination and does not accept that the replacement-asset rollover in Subdivision 124-B is available merely because an economically equivalent wrapped asset is received.

The broader legal context — Poulton v Conrad

The characterisation of crypto assets under Australian property law is also before the High Court in Poulton v Conrad. The appeal was heard on 13 August 2026 and concerns whether Bitcoin can be the subject of a proprietary relationship and, if so, whether it is capable of possession for the purposes of the torts of conversion and detinue. Judgment remains reserved.

The appeal arose from Poulton v Conrad [2025] TASFC 7, in which the Full Court of the Supreme Court of Tasmania dismissed the appeal and endorsed the view that Bitcoin is intangible property capable of possession through control of the relevant private key. That reasoning contemplates a category of intangible property outside the traditional division between choses in possession and choses in action.

The High Court’s decision will not itself determine the income tax treatment of airdrops or wrapping arrangements. However, its analysis of the nature of a taxpayer’s proprietary interest in Bitcoin, and the significance of control through private keys, may be relevant to the legal assumptions underlying the ATO’s view that ownership of an original crypto asset ends when it is wrapped. This issue also goes to the heart of the ATOs position, outlined in TD 2014/26 that bitcoin is property at law and is a CGT asset.

Taxpayers should therefore monitor both the final ATO guidance and the High Court’s judgment.

What taxpayers should do

• Identify the legal and commercial terms of each transaction.
• Distinguish business, income-producing, and private or recreational activities.
• Record the date, quantity, and Australian dollar market value of assets received or disposed of.
• Retain wallet records, transaction hashes, smart contract details, and exchange data.
• Consider both ordinary income and CGT consequences.
• Review whether previous returns are consistent with the ATO’s draft views.
• Obtain advice before entering into significant or unusual arrangements.

How SW can help

SW can assist crypto asset businesses and investors in assessing the income tax and CGT consequences of airdrops, wrapping, and unwrapping, as well as determining whether activities amount to carrying on a business, reviewing valuation methods and transaction records, and identifying transactions that may have triggered previously unrecognised tax consequences.

We can also consider whether prior-year positions should be reviewed and prepare supporting analysis while the ATO guidance remains in draft.

Please contact your SW advisor if you would like to discuss how the draft guidance applies to your arrangements.

Contributors

Stephen Peries | Senior Manager, Tax

The post The ATO’s draft tax guidance on crypto airdrops & wrapping appeared first on SW Accountants & Advisors.

The ATO’s aim, in publicising its programs and focus areas, is to encourage taxpayers to identify and address risks and to improve voluntary compliance.

This presents an opportunity for private groups to review their governance frameworks, validate tax positions, and ensure readiness for future interaction with the ATO.

Private wealth group demographics

The ATO estimates there are about 284,000 private wealth groups in Australia. These groups are divided into three categories, and each category is reviewed differently as part of the ATO’s compliance programs:

ATO focus areas for private wealth groups for the 25/26 income year 

Tax governance – a major (and increasing) priority  

Tax processes are likely to be more centralised and concentrated in private groups than in public groups. Nonetheless, the ATO expects privately owned and wealthy groups to maintain a documented tax governance framework that clearly outlines roles, responsibilities, and escalation protocols for tax issues.  

Aspects that the ATO are likely to focus on in this context include: 

• processes for active identification, monitoring, and management of tax risks 

• decision-making in relation to tax matters supported by documentation and specialist advice 

• alignment of frameworks and processes with the ATO’s justified trust framework. 

Claiming of CGT concessions  

A number of CGT concessions are flagged for attention by the ATO as being risk areas. These include:  

• eligibility for the CGT discount 

• groups that inappropriately seek to access the small business restructure rollover provisions 

• eligibility for other small business CGT concessions that are claimed  

• arrangements where capital gains are distributed to foreign beneficiaries of trusts and capital gains are disregarded.  

The ATO will be looking to ensure that eligibility conditions for the above concessions are met and appropriate documentation to support or evidence the concessions is maintained.    

Various issues relating to trusts  

Trusts are widely used in private groups and the ATO has indicated a particular interest in the following matters:  

• section 100A – distributing to lower-taxed beneficiaries where there is a reimbursement agreement under which a person or entity other than the beneficiary effectively obtains the use or benefit of the relevant funds 

• application of trustee beneficiary non disclosure tax where there are circular trust distributions 

• distributions made by trusts that have made a family trust election or interposed entity election outside the relevant ‘family group’ that may trigger family trust distribution tax 

• eligibility to claim franking credit tax offsets where distributions are made to newly incorporated company beneficiaries that may not meet the 45 day holding rule.  

Division 7A  

Division 7A is predictably a key area of focus of the ATO. In particular, they are monitoring common risk areas, including: 

• failure to make required minimum yearly repayments

• non-complying (or non-existent) loan agreements 

• arrangements designed to circumvent Division 7A with guarantees of third-party loans by private companies. 

Other issues on the hit list 

The ATO has also shown interest in several areas, including: 

• lifestyle assets, which potentially raise various tax issues (for example, lifestyle assets being treated as business related, rather than person use assets, Division 7A and GST issues) 

• succession planning – the ATO are interested in mechanisms employed in relation to intergenerational wealth transfer where business restructures or transfers of assets are involved. 

Property and construction industry 

The property and construction industry remains a focus for the ATO.  

Areas of focus including: 

• capital vs revenue treatment  

• GST and margin scheme 

• Non-arm’s length dealings within entities in the same private group to reduce their taxable income 

• Failure to lodge or report sales or income (particularly subcontractors) as identified by the ATO through the TPAR. 

Other industries 

Other industries of focus include the following:  

• tax advisers and professional firms 

• private equity transactions and activities  

• retail operations 

• cross-border transactions 

• crypto assets  

• use of tax-exempt or concessionally taxed entities (super funds and not-for-profit entities, including ancillary funds). 

How SW can help 

The ATO is increasingly active in conducting reviews and audits of private groups. Being aware of these key focus areas is essential. Preparing in advance helps private groups manage risks effectively and maintain strong governance, which can minimise potential issues and ensure compliance. 

SW have deep experience in advising private groups on tax governance frameworks, processes, and the various areas of interest highlighted above. We also have extensive experience in managing ATO reviews and audits.  

Please contact us should we be able to assist in ensuring that your group is well prepared for any ATO review.

Contributor

Shu En Hwang

The post Private groups – ATO identifies key focus areas for FY25 & FY26 appeared first on SW Accountants & Advisors.

My clients operate across a range of sectors, including education, IT, professional services, wholesale importing, property development and investment, and not-for-profit organisations.

I have demonstrated expertise in delivering high-quality outsourcing services to start-ups, SMEs, publicly listed companies, and Australian subsidiaries of large multinational groups.

I provide specialist advice on employment-related taxes, including GST, FBT, and salary packaging. I advise clients in the following areas:

• managing audit risk for indirect tax compliance
• payroll tax compliance and audits
• WorkCover obligations for employee and contractor arrangements
• PAYG withholding, including large withholder and foreign resident requirements
• Single Touch Payroll filing
• preparing instalment activity statements and business activity statements, and reporting to the ATO
• employee termination payments
• calculating long service leave, annual leave, and personal leave entitlements
• payroll software implementation and transition
• implementing streamlined payroll procedures to ensure accurate and timely payments to employees.

I am a Partner of SW Audit and a Director of SW Accountants & Advisors Pty Ltd.

The post Janelle McPhee, Partner appeared first on SW Accountants & Advisors.

In the 2023-24 Budget, the Government announced the implementation of a 15 per cent global minimum tax and domestic minimum tax, key aspects of Pillar Two of the OECD/G20 Two-Pillar Solution to address the tax challenges arising from the digitalisation of the economy.

The Two-Pillar Solution will ensure that multinational enterprises (MNEs) will be subject to a minimum effective tax rate of 15%, and will re-allocate profit of the largest and most profitable MNEs to countries worldwide. Under the OECD, 136 countries and jurisdictions have agreed to implement the new framework and proposed reforms.

After years of joint development, members of the G20/Organization for Economic Co-operation and Development (OECD) Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS) (the Inclusive Framework) agreed on the Two-Pillar Solution to address the Tax challenges arising from the Digitalization of the Economy. Two detailed blueprints were published in October 2022 on the tax reforms for addressing the Nexus and profit allocation challenges (Pillar One) and for Global Minimum Tax (GMT) rules (Pillar Two).

Who is affected?

Pillar One: will impact multinationals with revenues that exceed EUR 20b (~AUD 30b) per annum and have profit margins in ‘excess’ of 10%.

• Exclusions apply for extractives and regulated financial services
• Treasury currently estimates that no Australian headquartered multinationals would be impacted.  However Australian subsidiaries of foreign headquartered multinational groups may need to take into account any profits allocated to them in Australia.

Pillar Two: will have a far wider impact and applies to multinational groups with a global revenue of EUR 750m (~AUD 1.2b) per annum. 

• The OECD Framework excludes Government entities, international organisations (e.g. World Trade Organisation), non-profit organisations, pension funds or investment funds that are ultimate parent entities of an MNE Group or any holding vehicles used by such entities, organisations or funds from the scope of Pillar Two
• The OECD Framework includes de-minimis exemptions based on the revenue and profits within particular jurisdictions
• Further breakdown on each pillar can be found below.

When does it come into effect?

There is currently no draft legislation and no specified start date. However, it is expected that:

• Pillar One: the start date is to be announced.
• Pillar Two:
  • The Income Inclusion Rule which will apply for income years starting on or after 1 January 2024. This rule will apply to Australian multinationals and Australian entities which are subsidiaries of a foreign-headquartered multinational located in a jurisdiction that has not implemented this rule.
  • The Undertaxed Profits Rule which will apply for income years starting on or after 1 January 2025. Where no Income Inclusion Rule applies, the Undertaxed Profits Rule will apply to foreign multinationals that operate in Australia

How can SW help?

SW can help your business prepare for the international corporate tax reform, by assisting with the following: 

• Review of current corporate structure to determine if Pillar One and/or Pillar Two will apply
• Implement systems to assist with compliance with the new rules. 
• Formulate tax procedures and control framework to comply with the new rules.

If either, or both, Pillar One and Pillar Two are found to apply, we can provide the following services:

• Review bilateral tax treaties to determine if the STTR applies
• Model the impact of the rules
• Review transfer pricing agreements to determine risks and advise on changes to mitigate risks
• Determine where any remaining risks areas are and propose actions items to mitigate risks
• Lodge Global Anti-Base Erosion (GloBE) returns with the ATO.  This lodgement is likely to be required regardless of whether a top-up tax liability exists.

SW held a seminar to discuss the operation of the rules in greater details. you can access the webinar video here.

Key elements of the Two-Pillar Solution

Pillar One

Under Pillar One, MNEs will need to determine whether their profit margin (profit before tax ÷ revenue) exceeds 10%. The excess being referred to as “residual profits”.

A quarter of the residual profits would be redistributed to the countries where the products or services are consumed, to be taxed in those jurisdictions. The allocation of the residual profits to source jurisdictions will broadly be based on the revenue sourced from those jurisdictions. There will be some de-minimis exclusions.

What are the key implications for affected taxpayers?

• Systems and processes should be implemented to meet this compliance requirement
• Subsidiaries based in Australia may need to consider any profits allocated to Australia before finalisation of their income tax returns
• Global transfer pricing policies will need to be reviewed in light of the new rules
• The tax impact should be modelled.

Pillar Two

Pillar Two is also referred to as the Global Anti-Base Erosion or Global Minimum Tax rules.

Objectives of Pillar Two

The objective of Pillar Two is to set a minimum Effective Tax Rate (ETR) to reduce incentives for multinational to move profits to low tax jurisdictions.

Calculating the ETR

• The ETR is not the corporate tax rate in the country. It is similar to how the effective tax rate is calculated under the accounting rules but will not be the same as the calculation required under the Pillar Two rules.  
• The ETR = Adjusted Covered Taxes ÷ Net GloBE Income. The minimum ETR is 15% and is calculated on a jurisdictional basis.
• The financial accounts and tax effect accounting balances will be used in the calculation of the ETR to better align the financial accounts with tax purposes. The net GloBE income will generally be the accounting profits used in the parent entity’s consolidated financial statements subject to certain adjustments (see below).
• In calculating the net GloBE income, there will be some adjustments for certain permanent differences such as removing dividends and equity gains. The OECD framework also includes an exclusion for international shipping income.
• In calculating the net covered taxes, only tax on profits are relevant. Indirect taxes are excluded. Further, there are rules for addressing temporary differences. Therefore, the tax effect accounting workpapers will be relevant in calculating the ETR.
• Tax losses brought forward can broadly be carried forward and applied in the calculations.
• There are also adjustments to Net Globe Income based on the level of employment costs and tangible assets in each jurisdiction.  This would reduce the profits subject to the top-up tax.
• As the calculations are complicated, SW will hold seminars when the legislation is released to discuss the operation of the rules in greater detail.
• If subsidiaries in a jurisdiction have an effective tax rate of <15% (say 10%), then the parent entity jurisdiction can levy a “top-up” tax of the difference i.e. 5% (15%-10%) on the relevant profits in the jurisdiction. This is referred to as the Income Inclusion Rule (IIR). This tax is in addition to the tax paid by the parent company on its own profits.
• Where the top-up tax amount is not fully covered by the IIR, then the Undertaxed Payment Rule (UTPR) will operate as a stop gap measure. In general, the remaining top-up tax will be allocated to the all the jurisdictions (in which the MNE operates) which have implemented the GloBE rules.
• Before calculating the IIR and UTPR, the Subject To Tax Rule (STTR) must firstly be considered. The STTR prevents companies from avoiding tax on their profit earned in developing countries by making deductible payments such as interest or royalties that benefit from reduced withholding tax rates under tax treaties and which are not taxed (or taxed at a low rate) under the tax laws in the treaty partner. In this case, the payer’s jurisdiction can levy an additional top-up withholding tax so that the income amount is subject to a minimum tax (in both countries together) of 9%. This is lower than the minimum 15% tax on profits because the STTR tax is calculated based on the gross amount.

Operation of Pillar Two

Step 1. Subject to tax rule (STTR)

Objective: Ensure that developing countries have an equal opportunity to tax certain types of income.

Implementation:

• Participating members who are taxing certain items of income below 9% will be required to include the STTR into a bilateral tax treaty when requested by a developing treaty partner.
• When the STTRs are included in a bilateral tax treaty, the payer jurisdiction may additionally tax certain related party payments if the receipt is taxed at a rate of less than 9% in the payee’s jurisdiction.
• This taxing right will be capped at the difference between the STTR minimum tax rate and the tax rate on the payment.

Impact on Australian taxpayers

The STTR is expected to have limited application to Australian taxpayers given our corporate tax rate and withholding tax system.  However, this will need to be monitored to confirm that affected payments have been subject to the minimum 9% tax.

Step 2. IIR and UTPR

Once the STTR has been considered, the next step is to consider the IIR and UTPR rules.

Objective: Ensure an effective minimum 15% effective rate is imposed on multinationals with a global revenue of EUR 750 million (~AUD 1.2 billion) per annum. 

Implementation: These rules would be carried out through two interlocking rules. Together they would work to collect a top-up tax on profits in jurisdictions which are deemed to be ‘undertaxed’.

• Income inclusion rule (IIR) – is the primary charging mechanism which would allow the parent company jurisdiction to apply a top-up tax on resident multinational ‘parent’ companies, where the group’s income in another jurisdiction is being taxed below the global minimum rate of 15%. Note that there are special rules applying to overseas branches of the parent company which operate differently to the IIR.
• Undertaxed payments rule (UTPR) – where the parent company jurisdiction does not implement the IIR or the top-top up tax is not fully captured by the IIR, then the UTPR as the secondary charging mechanism would broadly allocate the remaining top-up tax to all the implementing jurisdictions in which the MNE operates.
• For example, if a multinational subsidiary in Australia had a foreign subsidiary paying less than the global minimum rate on its profits, and there was no foreign jurisdiction applying the IIR in relation to those profits, then Australia may be required to apply the UTPR to the Australian subsidiary in respect of the under-taxation in the foreign subsidiary’s jurisdiction. 

How can affected taxpayers prepare?

• Systems and processes will need to be implemented to allow for an effective and efficient calculation of the effective tax rates and completion of the GloBE information return
• The impact on the MNE group should be modelled
• Review current transfer pricing agreements to determine how they would be impacted by Pillar One and Pillar Two.

Contributors

Kate Wittman

The post Major international tax reform with OECD Two-Pillar approach appeared first on SW Accountants & Advisors.

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. 

Apportionment

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.

SGE penalties

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.

Contributors

Tony Principe

Wasi Hussain

Rahul Sanghani

The post Australian Treasury denies SGEs deductions for payment relating to intangibles appeared first on SW Accountants & Advisors.

The Taxpayer Alert notes that participants in, and promoters of these types of arrangements, may be subject to penalties, including promotor penalties under Div 290 of Sch 1 to the Taxation Administration Act 1953.

Background on Division 7A

Division 7A (Div 7A) is a far reaching set of provisions the essential purpose of which is to treat certain payments and non-commercial loans made by private companies to shareholders or their associates as a distribution of profits and therefore a deemed (unfranked) dividend.

For a deemed dividend to arise, the relevant private company must have what is referred to in the legislation as a ‘distributable surplus’ (which is very broadly profits, reserves or surplus funds from which a dividend could theoretically be declared).

What types of arrangements is the ATO looking at?

Arrangements that are flagged by Taxpayer Alert TA 2023/1 as being high risk and in the crosshairs of the Commissioner are arrangements along the following lines:

• An individual who is a shareholder and director of a private company with retained profits.
• The individual disposes of their shares in the private company to an interposed holding company (set up by the individual) and receives shares in the interposed holding company in return.
• The value of the shares received in the interposed holding company equate to the net asset value of the private company, with the result that the interposed company has no ‘distributable surplus’ available for distribution.
• The individual applies CGT roll-over to disregard, for tax purposes, any capital gain arising on the disposal of the shares in the private company.
• The private company declares a franked dividend to the interposed holding company. Whilst the TA does not explicitly state this, it is expected that the dividend received by the interposed holding company (being a dividend received from pre-acquisition profits of the private company) would be recorded for accounting purposes as a reduction in the book value of the asset, rather than a receipt of profit. 
• The private company discharges its liability to pay the dividend by ways such as cash, cheque or promissory note.
• The individual receives a loan from the interposed holding company, financed by the dividend received from the private company. The terms of the loan do not comply with Division 7A (which requires loans to meet criteria such as a minimum interest rate and maximum term).
• Whilst the loan is not on complying Division 7A terms, taxpayers are taking the position that Division 7A would not apply due to the absence of a distributable surplus in both the private company and the interposed holding company. 

TA 2023/1 also indicates that the Commissioner would be equally concerned should a similar arrangement be entered into where the relevant shareholder is a trust, rather than an individual.  

Grounds to challenge

On the basis that arrangements such as the above exhibit a high degree of contrivance and would appear to be motivated by an objective of avoiding the application of Division 7A, TA 2023/1 notes that the Commissioner would be likely to challenge the arrangement on the following alternative bases:

• the Commissioner may assert that the loan is not a genuine loan, but a payment that is assessable as an unfranked dividend under the deemed dividend rules in Division 7A
• the arrangement may be challenged as a ‘dividend stripping’ scheme resulting in the loan amount being included in assessable income of the original shareholder and the franking credit on the dividend paid to the interposed holding company being cancelled
• under the general anti avoidance rules in Part IVA.

How SW can help

While the circumstances at which TA 2023/1 are directed are quite specific and may not affect many of our clients, the Taxpayer Alert highlights the efforts that the ATO are applying to enforce Division 7A.

Should you have any queries in relation to this Taxpayer Alert or Division 7A more generally, please reach out to your SW contact or Key Contacts here.

Contributors

Tanya Bester

The post ATO targets Division 7A avoidance scheme appeared first on SW Accountants & Advisors.

On 23 February 2022, the Commissioner released Draft Determination TD 2022/D2, addressing the deductibility of expenses incurred when establishing and administering an Employee Share Scheme (ESS).

The Commissioner has stated expenses incurred from the establishment and/or amendment of an Employee Share Scheme (ESS) are not deductible under section 8-1 of the ITAA 1997 as they are viewed as capital in nature. This may be seen as a departure from a general view that employee costs are more typically revenue in nature.

Expenses not deductible

Establishment fees can include:

• Legal fees incurred from establishing an Employee Share Trust (EST) or ESS plan rules
• Start-up costs, such as commencement charges for a trustee company, or
• Registration fees with authorities such as stamp duty or ASIC fees.

Amendment fees can include:

• Legal fees paid to amend either the EST or ESS plan rules, or
• Regulatory fees and stamp duty paid to authorities.

To the extent that the business is carried on for a taxable purpose, both establishment and amendment fees would be deductible to the employer company in equal proportions over 5 years under section 40-880 of the ITAA 1997.  

Section 40-880; commonly referred to as ‘black-hole expenditure’ provides a deduction for certain capital expenditure of a business on a straight-line basis over a 5-year period.  Section 40-880 only applies to capital costs incurred in relation to a past, present, or proposed business that is not otherwise dealt with under other income tax provisions. 

The Commissioner did confirm however, that the ongoing expenses associated with the administration of an ESS should be deductible under section 8-1 of the ITAA 1997.  

Deductible expenses

Ongoing expenses include:

• brokerage fees
• audit fees
• bank charges
• making new offers to employees under an existing ESS, or
• other ongoing administrative expenses.

Fees relating to annual ESS reporting should continue to be deductible, however questions must now be raised as to whether the ATO’s view will impact on broader issues such as the tax treatment of contributions to employee share trusts and expenses they incur. 

How SW can assist

Once TD 2022/D2 is finalised by the ATO, it is important to note the determination will apply both prospectively and retrospectively.

If you want to discuss any of the aspects of this draft determination or concerns regarding your existing or future ESS, please contact your SW advisor or one of our experts.

Contributors

Justin Batticciotto

E: jbatticciotto@sw-au.com

The post Employee Share Schemes: Deductibility of expenses appeared first on SW Accountants & Advisors.

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