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© Collins, Bona and Landsberg 2016

Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

2016 QUEENSLAND TAX

FORUM

Session 11B: Coveting thy neighbour’s tax

base – Australia’s changing approach to

international taxation

Written by:

Michael Bona, CTA

Partner

PricewaterhouseCoopers

Peter Collins, FTI

Partner


Presented by:

Michael Bona, CTA

Partner


Stuart Landsberg, FTI

Partner


Peter Collins, FTI

Partner


Queensland Division

18 - 19 August 2016

Brisbane Marriott Hotel, Brisbane

Collins, Bona and Landsberg Coveting thy neighbour’s tax base

© Collins, Bona and Landsberg 2016 2

CONTENTS 1. Overview ......................................................................................................................................... 3

2. A changing approach to financing transactions ........................................................................ 4

2.1. Chevron and loan documentation ............................................................................................. 4

2.2. Reconstruction .......................................................................................................................... 6

2.3. Administrative guidance ............................................................................................................ 8

2.4. Conclusion .............................................................................................................................. 10

3. Australia’s unilateral measures – the MAAL and DPT ............................................................. 11

3.1. Overview ................................................................................................................................. 11

3.2. The Australian MAAL .............................................................................................................. 12

3.2.1. Purpose ........................................................................................................................... 12

3.3. Design ..................................................................................................................................... 12

3.3.1. Consequences ................................................................................................................. 14

3.3.2. Practical responses ......................................................................................................... 16

3.4. The Australian DPT ................................................................................................................. 17

4. Implementing the BEPS agenda ................................................................................................. 20

4.1. Hybrid mismatch rules ............................................................................................................ 20

4.1.1. Overview .......................................................................................................................... 20

4.1.2. Hybrid payments .............................................................................................................. 21

4.1.3. Hybrid entities .................................................................................................................. 22

4.1.4. Imported mismatch rules ................................................................................................. 24

4.1.5. Hybrid mismatch rules – conclusion ................................................................................ 25

5. Conclusion .................................................................................................................................... 27



1. Overview

Australia is experiencing an unprecedented wave of international tax reform. The proximate cause of

these reforms vary, some reform is undertaken in compliance with the OECD’s Base Erosion and

Profit Shifting (BEPS) project to which Australia has shown fervent support. Other reforms are

unilateral in nature and fundamentally driven by domestic politics.

However, whilst the proximate causes may vary, the reforms share a common ultimate cause; a

desire to defend and grow the revenue collected from multinational enterprises (MNEs) through

politically palatable ‘integrity measures’ at a time when broad-based genuine tax reform seems

politically unachievable.

This motivation may appear logical given the pressures faced by the Australian Federal Government,

including stagnant revenue collections, public perception that multinational enterprises (MNE) are not

‘paying their fair share’ and a widespread view that the architecture of the international tax system has

not kept pace with the rapid globalisation of business.

However, where integrity measures exist without comprehensive tax reform, the cumulative effect

arguably amounts to a ‘coveting of thy neighbour’s tax base’. In a world of increased tax competition1,

this may be an inappropriate approach for a nation such as Australia that relies so heavily on foreign

investment.

This paper will survey a number of areas of changed administrative or legislative approach (both

enacted and announced but unenacted) to international taxation, including:

related party financing;

Australia’s unilateral approach to the avoidance of permanent establishments (the

multinational anti-avoidance law or ‘MAAL’) and profit shifting (the diverted profits tax or

‘DPT’); and

the OECD’s recommendations on combating hybrid mismatch arrangements.

1 See for example, the UK’s proposal to reduce the corporation tax rate to 15% as announced by the Chancellor of the

Exchequer; George Osborne puts corporation tax cut at heart of Brexit recovery plan, Financial Times, 4 July 2016.



2. A changing approach to financing transactions

The outcomes of Australia’s first substantive transfer pricing case on financing transactions Chevron

Australia Holdings Pty Ltd v Commissioner of Taxation (No 4)2 (Chevron) the BEPS focus on

financing3 and renewed ATO consideration of administrative guidance in respect of transfer pricing

collectively mean that many taxpayers and their advisers are considering what is the appropriate

approach to transfer pricing.

This paper will consider:

practical impact of Chevron on documenting financing transactions (noting that the case is on

appeal4);

the potential impact for the Commissioner to reconstruct financing transactions having regard

to Chevron and Subdivision 815-B5; and

possible changes to the ATO’s approach to financing transactions.

2.1. Chevron and loan documentation

The purpose of this section is not to analyse at length the reasoning in Chevron and the possible

implications under Division 815-B because this exercise has been undertaken by others6. In addition,

given the pending appeal, the case’s focus on Division 13 and Subdivision 815-A (superseded by

Subdivision 815-B) and the significant changes in the approach to transfer pricing in the past decade

(the Credit Facility Agreement in Chevron was dated 6 June 2003) it could be argued that seeking

guidance from the decision of Robertson J should be approached with caution.

However, notwithstanding these limitations, as the first substantive transfer pricing case in respect of

financing transactions in Australia, Chevron does highlight some practical learnings for taxpayers and

their advisers.

Ultimately, the Commissioner succeeded in respect of the Division 13 matter because, in Justice

Robertson’s eyes, the taxpayer failed to discharge the statutory onus imposed by section 14ZZO of

the Tax Administration Act (TAA) 1953 to demonstrate that the assessments were excessive:

“In my opinion, therefore, the applicant has not shown that the consideration in the Credit

Facility Agreement was the arm’s length consideration or less than the arm’s length

2 [2015] FCA 1092. 3 Primarily contained in Action 4 (thin capitalisation) but also impacted by Action 2 (neutralise hybrid mismatches), Action 3

(strengthen CFC rules), Action 5 (counter harmful tax practices) and Action 6 (prevent treaty abuse). 4 Due to be heard in the week commencing 29 August 2016 by Allsop CJ, Perram J and Pagone J. 5 In particular, sections 815-130 and 815-140. 6 Refer papers for the TTI including: Jenkins, M., Transfer pricing – ATO perspectives, (The Tax Institute, May 2015) and

Lannan, B. and Xhemajlaj D., The Transfer Pricing “Reconstruction” Provisions: Recharacterising, Repricing or Reimagining,

(The Tax Institute, August 2015) and Preshaw, Transfer pricing and the Chevron case (The Tax Institute, 2016).



consideration nor proved that the amended assessments under Div 13 of the ITAA 1936 were

excessive.”7

This conclusion was largely derived from Justice Robertson’s finding that:

“In the present case I find that CAHPL did not give security or operational and financial

covenants, which would have affected that part of the consideration which was the interest rate:

the interest rate was higher in the absence of those promises or covenants. If the property

had been acquired under an agreement between independent parties dealing at arm’s

length with each other, I find that the borrower would have given such security and

operational and financial covenants and the interest rate, as a consequence, would have

been lower. The limited scope of the consideration given or agreed to be given by CAHPL

resulted in the consideration which CAHPL did give, the promise to pay the interest rate,

exceeding the arm’s length consideration in respect of the acquisition. It follows, on that basis,

that the applicant has not shown that the arm’s length consideration assessed by the

respondent Commissioner was excessive.”8 [emphasis added].

The conclusion regarding the appropriate consideration (on a covenant inclusive basis) led to

Robertson J dismissing most of the testimony by expert witnesses on both sides.

In particular, Robertson J’s dismissal of three of the applicant’s witnesses who gave evidence on

pricing, Mr Richard Gross, Mr Eugene Martin and Dr Brian Becker, contained criticisms in relation to

their failure to have regard to the lack of restrictive covenants contained in the Credit Facility

Agreement and the implication that the comparable transactions that they found were therefore,

according to Robertson J, inappropriate given the presence of covenants in these agreements

(including Term Loan B agreements).

Despite the prospects of all these matters being challenged in the appeal, it is this conclusion that

provides guidance as to the practical issues that should be considered for internal financing

transactions being undertaken today.

Based on Chevron, and ATO practice on audits, it is likely that a taxpayer’s ability to rely on

comparable uncontrolled prices (CUPs) will be influenced by the extent to which the tested transaction

contains similar terms or conditions to the transaction being used as a CUP.

In this respect, the use of short-form loan agreements for significant intra-group financing transactions

may limit the ability to rely on certain transactions as appropriate CUPs. Accordingly, drafting intra-

group agreements to more closely resemble the comparable transactions being used to substantiate

the pricing, is likely to be helpful.

This is not to say that all intra-group agreements will need to become voluminous documents full of

covenants and non-price sensitive terms and conditions – the appropriate level of documentation (and

terms and conditions) should be assessed on a case by case basis as appropriate for that specific

transaction.

7 [2015] FCA 1092 at [525]. 8 [2015] FCA 1092 at [87].



However, where pricing significant related party borrowings, it may make the task of selecting and

relying on comparable transactions more straightforward if the tested transaction has terms and

conditions that are similar to the CUPs being used. Ultimately, the extent to which comparable

transactions can be relied upon could be key to the taxpayer being able to discharge their onus in

court.

In addition, the approach adopted in Chevron is likely to further encourage taxpayers to explore

whether other arrangements seen in the ‘real wold’, such guarantees, line and facility fees should be

a feature of related party financing transactions.

In an economic environment where capital is relatively cheap, but onerous in terms of the demands

placed by financiers, the most difficult issue to address is the related party financing facilities that fund

some of the largest Australian resourcing projects and infrastructure facilities. These facilities are

often too large to fit within the weighted credit risk tolerances of domestic financiers (or international)

and consequently, are generally only observed in bond markets or multi-financier syndicated

arrangements.

This fact was the subject of some evidence in the Chevron case. That evidence suggested that a

facility of the size of the Chevron facility could not possibly have come from a single bank. Whether a

related party loan of this size needs to conform broadly to the structure of these observable

comparables did not get clarified at first instance. However, this is going to be a key issue for the "big

end of town" as facilities grown or are refinanced. To price that type of arrangement is not a simple

task.

2.2. Reconstruction

The potential for the Commissioner to ‘‘reconstruct’ financial arrangements under the transfer pricing

provisions has been a long standing concern for taxpayers.

In Chevron, it was a matter for debate between the parties as to whether the Commissioner’s

proposition that the relevant loan should be priced as if it was USD denominated amounted to a

reconstruction of the transaction. Robertson J rejected the Commissioner’s endeavour to price the

loan as if it was USD denominated.

However, it is relevant to consider whether the specific reconstructive power contained in section 815-

130 would affect this analysis for arrangements covered by subdivision 815-B. In this respect, the

author’s note that section 815-130 contains the high threshold for reconstruction that:

“independent entities dealing wholly independently with one another in comparable

circumstances would not have entered into the actual commercial or financial relations”

9[emphasis added].

9 Section 815-130(3)(a) of the ITAA 1997.



In practice, this threshold may limit the scope of the reconstruction power significantly given the broad

range of financial instruments that independent parties could enter into. The scope of reconstructing

financial arrangements, particularly for example reconstructing a borrowing into an equity investment,

is further limited by section 815-140 which effectively legislates TR 2010/7 requiring that the arm’s

length price be applied to the debt interests actually issued.10 This approach also seems consistent

with the 2010 OECD transfer pricing guidelines which state that "[i]n other than exceptional cases, the

tax administration should not disregard the actual transactions or substitute other transactions for

them". The amendments to the OECD transfer pricing guidelines11 reinforce the limited circumstances

in which transactions can be disregarded for transfer pricing purposes:

“1.121 Every effort should be made to determine pricing for the actual transaction as

accurately delineated under the arm’s length principle..

1.122 …Because non-recognition can be contentious and a source of double taxation,

every effort should be made to determine the actual nature of the transaction and apply

arm’s length pricing to the accurately delineated transaction, and to ensure that non-

recognition is not used simply because determining an arm’s length price is difficult.

Where the same transaction can be seen between independent parties in comparable

circumstances (i.e. where all economically relevant characteristics are the same as those

under which the tested transaction occurs other than that the parties are associated

enterprises) non-recognition would not apply. Importantly, the mere fact that the

transaction may not be seen between independent parties does not mean that it should

not be recognised. Associated enterprises may have the ability to enter into a much greater

variety of arrangements than can independent enterprises, and may conclude transactions of

a specific nature that are not encountered, or are only very rarely encountered, between

independent parties, and may do so for sound business reasons. The transaction as

accurately delineated may be disregarded, and if appropriate, replaced by an alternative

transaction, where the arrangements made in relation to the transaction, viewed in their

totality, differ from those which would have been adopted by independent enterprises

behaving in a commercially rational manner in comparable circumstances, thereby preventing

determination of a price that would be acceptable to both of the parties taking into account

their respective perspectives and the options realistically available to each of them at the time

of entering into the transaction. It is also a relevant pointer to consider whether the MNE

group as a whole is left worse off on a pre-tax basis since this may be an indicator that the

transaction viewed in its entirety lacks the commercial rationality of arrangements between

unrelated parties.

1.123 The key question in the analysis is whether the actual transaction possesses the

commercial rationality of arrangements that would be agreed between unrelated parties under

comparable economic circumstances, not whether the same transaction can be observed

between independent parties. The non-recognition of a transaction that possesses the

commercial rationality of an arm’s length arrangement is not an appropriate application of the

arm’s length principle. Restructuring of legitimate business transactions would be a wholly

10 Section 815-140(2)(b) of the ITAA 1997. 11 As per BEPS Actions 8-10 (OECD (2015), Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 - 2015 Final

Reports, OECD Publishing, Paris) and approved by the OECD Council on 23 May 2016.



arbitrary exercise the inequity of which could be compounded by double taxation created

where the other tax administration does not share the same views as to how the transaction

should be structured. It should again be noted that the mere fact that the transaction

may not be seen between independent parties does not mean that it does not have

characteristics of an arm’s length arrangement.” [Emphasis added]

The Government in the 2016-17 Budget that has announced that these new guidelines would be

incorporated into Australian law for years beginning on or after 1 July 2016.

The combination of these provisions means that the Commissioner’s powers to reconstruct a

taxpayer’s borrowing may be far more limited than first suggested in the coverage regarding the

introduction of Subdivision 815-B – particularly where the taxpayer has properly considered arm's

length terms within the agreement which reflect the substance of the arrangements. In practical

terms, this is likely to mean that taxpayers should anticipate that the ATO can only ‘reconstruct’ a

capital structure in very rare circumstances. Of course, it will always be necessary to ensure that the

‘pricing condition’ (viz the interest rate) can be supported.

After moving through this reconstruction hurdle, the question that then arises is how the operative

provision does in fact reconstruct the actual arrangement between the parties. The legislation uses

the word "condition" and the operative point of reconstruction. This expression, read at its narrowest,

suggests that the Commissioner might only be able to alter the price or similar contractual term - not

the fundamental structure. This will be a very important point to interpret given that the reconstruction

operates for all purposes of the Act.

2.3. Administrative guidance

Despite the relative lack of judicial guidance regarding transfer pricing aspects of financial

transactions, the Australian Taxation Office (ATO) has provided numerous rulings on this topic

including:

Taxation Ruling (TR) 1992/11 – which provides a (relatively) comprehensive analysis of the

application of Division 13 of the Income Tax Assessment Act (ITAA) 1936 to loan

transactions;

TR 1994/14 – which in setting out a broad overview of the basic concepts underpinning

Division 13 also touches on certain specific financing matters;

TR 2005/11 – which considers branch funding for multinational banks (given the specific

nature of this ruling this issue is not discussed further in this paper);

TR 2007/1 – which suggests that the Commissioner will rarely seek to apply the Division 13

transfer pricing rules to interest free loans to residents (replaced TR 1999/8 which was

withdrawn on 7 March 2007);

TD 2008/20 – which concludes that the Division 974 characterisation of a financial

arrangement does not bear upon the transfer pricing outcome;

TR 2010/7 – which considers the interaction of the transfer pricing provisions with the thin

capitalisation rules – whilst the ruling is in the context of Division 13, the outcome is effectively

codified in Subdivision 815-B (specifically section 815-140); and



TR 2014/6 – which considers the application of the reconstruction provisions contained in

section 815-130 and specifically considers the interaction of the reconstruction provisions with

section 815-140.

It is noted that the majority of these rulings precede the re-write of the transfer pricing provisions from

Division 13 to subdivisions 815-A and 815-B respectively. The Division 815 Working Group has been

considering the continued applicability of existing guidance given the re-written legislation and,

although no final decisions have been made, it seems that the ATO’s current inclination is to dispense

with certain aspects of these long standing rulings and administrative practice.

In this respect, the 22 July 2016 public rulings program include the following which could reflect a

change in administrative approach:

proposed taxation ruling “Income tax: the interaction of the transfer pricing rules in

Subdivision 815-B of the ITAA 1997 with the debt/equity tests in Division 974 of the ITAA

1997” and;

proposed taxation determination “Income tax: does an entity get a transfer pricing benefit for

the purposes of section 815-120 of Subdivision 815-B of the Income Tax Assessment Act

1997 (ITAA 1997) from an outbound or inbound interest free loan”.

In addition, at the 22 July 2016 final meeting of the Division 815 Working Group, the ATO indicated

that it is looking at the circumstances where a consequential adjustment may be provided under s815-

145 (e.g. in the context of interest free loans) and a PCG12 regarding the conditions for a loan to be

arm’s length.

The proposed taxation determination could potentially express a different view to that contained in

paragraphs 51-61 of TR 92/11 regarding the issues to be considered in determining whether a loan is

in substance a contribution to equity, as well as potentially disturbing the outcome expressed at

paragraph 16 of TR 2007/1 that:

“In situations where there is a commercial reason for the interest free loan and the interest

free loan has not by itself disadvantaged the revenue, it would not be appropriate for the

Commissioner to make a subsection 136AD(2) determination and adjustment against the

non-resident company to raise the withholding tax liability in the first instance. Such an

interest free loan arrangement does not involve the allowance of a deduction to the Australian

borrower and, thus, has not by itself disadvantaged the Australian revenue.”

Given the prevalence of interest free loans (IFLs) in the resources sector (e.g. in pre "bankable"

exploration phases), any changes to the transfer pricing treatment of outbound or inbound quasi-

equity loans could be significant. Of course, if the Commissioner proposes a ‘U-Turn’ in this area, it

would be critical to examine the many flow-on consequences. For example, outbound IFLs could

perhaps be structured to access subdivision 768-A which now provides an exemption for interest

12 ATO Practical Compliance Guideline (PCG) – which is a new ATO product that “provide[s] broad law administration

guidance, addressing the practical implications of tax laws and outlining our administrative approach”.



received in respect of certain non-share equity and the terms of Division 815-B may require the

Commissioner to provide a deduction for notional interest in respect of inbound IFLs.

Unfortunately, history tells us that the ATO is notoriously thoughtful13 in issuing any public rulings in

relation to substantive transfer pricing issues. For this reason, we should not be expecting any of this

promised guidance to be finalised any time soon.

In the meantime, this means the rest of us will be providing advice to clients, or taking decisions for

our businesses, in real time and hoping that the ATO eventually reaches similar views.

2.4. Conclusion

The landscape for transfer pricing of financing arrangements appears to be changing as a result of

Chevron and changing administrative practice.

The practical ramifications of these changes are still being determined but we would highlight these

key considerations in the context of financing transactions:

comparable transactions used to support pricing are true ‘comparables’ (including having

regard to legal terms and conditions);

reliance is being placed on administrative guidance which may no longer be binding on the

Commissioner (and whether new guidance reflects a change in interpretation by the ATO);

and

the operation of section 815-140 might mean that for ‘inbound loans’ a strategy of ‘high’ debt

(within thin capitalisation limits14) and ‘conservative’ (others may describe as less than arm’s

length!) interest rates might be a sensible approach to explore15.

13 TR 2010/7 (referred to above) was almost 4 years in the making. This included the ATO process of ensuring that this ruling

was not a ‘U-Turn’ (as per PSLA 2011/27) in relation to aspects of TR 92/11 and ATO administrative practice.. 14 In Chevron the Australian group apparently had gearing of 47% of assets [2015] FCA 1092 at [322, 336, 418] at a time when

the Australian thin capitalisation rules permitted 75%. In other words, debt levels could have been increased by almost 60%

without breaching the thin capitalisation restrictions. 15 Of course, whether the lender jurisdiction is comfortable with this ‘low ball’ strategy is another factor to address, as is

consideration of the interaction with withholding tax and whether the associated reduction in withholding tax gives rise to a

“transfer pricing benefit” under Australian law.



3. Australia’s unilateral measures – the MAAL

and DPT

3.1. Overview

The MAAL and DPT represent the high point of Australia’s coveting of other jurisdictions’ tax base.

These measures are unilateral and only tangentially connected to the BEPS agenda. Both measures

were announced as budget measures (the MAAL in the 2015-16 budget, the DPT in the 2016-17

budget) and appear to be a response to revenue authority and public concern in respect of

international tax avoidance – particularly in respect of certain high profile technology companies16.

Whilst the measures arguably have some alignment with BEPS measures (for example, Action 7

Preventing the Artificial Avoidance of Permanent Establishment), they do not relate directly to any

BEPS recommendations. Instead, the acts are directly inspired by the United Kingdom’s Diverted

Profits Tax which applies from April 2015.

The UK’s DPT encompasses in one act what Australia took two acts to do:

a) prevent (via punitive tax) the avoidance of a taxable presence (a.k.a PE) – the objective of

Australia’s MAAL; and

b) punitively tax arrangements which involve entities or transactions lacking economic substance

– the apparent objective of Australia’s DPT.

Both the Australian and UK taxes could arguably be seen to breach double tax treaty obligations but

each country has chosen a different method to try to avoid such obstacles. The UK introduced the

DPT as an entirely separate tax whereas Australia introduced the MAAL (and is likely to introduce the

DPT) within its anti-avoidance regime therefore arguably over-riding its treaty obligations17.

In any case, whilst there are a number of similarities between the MAAL and the proposed DPT, they

are fundamentally different in purpose, effect and operation and therefore it is worth considering each

tax in more detail separately.

16 Senate Economics Reference Committee. (2015) Corporate tax avoidance Part 1 - You cannot tax what you cannot see,

Commonwealth of Australia. 17 Section 4(2) of the International Tax Agreements Act 1953



3.2. The Australian MAAL

3.2.1. Purpose

Briefly, the Australian MAAL was announced by the 2015-16 budget (or technically in a media release

the day before the budget18). In a series of assertions that, prima facie, appear to be incorrect, the

Treasurer suggested that:

The “measure deals with the activities of 30 identified multinational companies” – subsequent

to its introduction, the ATO has sent letters to significantly in excess of 30 taxpayers (‘over

170’19 according to the ATO) advising them that they appear to be within the MAAL;

Australia does not require a diverted profits tax - “[a]fter consultation with the United Kingdom

it is clear that we do not need to replicate their Diverted Profits Tax” – less than one year later

the DPT was announced; and

“[T]he BEPS program that has helped facilitate this measure” – Pascal Saint-Amans said

about the MAAL that “[t]hese measures were not helpful… [a]nd may not happen to extent

that they will be superseded by BEPS measures. BEPS is more consistent with what's been

agreed internationally, than what Australia currently has.”20

However, notwithstanding the arguably false premises on which the MAAL was introduced, it was

enacted into law by the Tax Laws Amendment (Combating Multinational Tax Avoidance) Act 2015

and therefore, rather than railing against its necessity, it is more productive to consider its

implications.

The MAAL had a tumultuous journey through Parliament. The original Bill was introduced on 16

September 2015 and passed, after 10 proposed amendments in the Senate, on 3 December

2015 and took effect from 1 January 2016.

3.3. Design

They key features of the MAAL are:

it is an amendment to the anti-avoidance provisions in Part IVA (with the associated

benefit of arguably not being constrained by treaties);

18 Hockey, J (Treasurer, Commonwealth of Australia) 2015, Strengthening the tax system, Media Release, Commonwealth of

Australia, 11 May, viewed 14 July 2016, <http://jbh.ministers.treasury.gov.au/media-release/040-2015/> 19 Jeremy Hirschorn quoted by Ryan P, (2016, 27 April). Multinational tax avoidance may need to be strengthened further: ATO.

ABC Online. Retrieved from <http://mobile.abc.net.au/news/2016-04-26/multinational-tax-avoidance-crackdown-flagged-by-

ato/7360774?pfm=sm&section=business> 20 Pascal St-Amans quoted by Khadem, N, (2015, 5 October). Hockey’s laws to fight multinationals will be ‘superseded’ by final

BEPS plan, OECD says. Fairfax Media. Retrieved from <http://www.brisbanetimes.com.au/business/the-economy/hockeys-

laws-to-fight-multinationals-will-be-superseded-by-final-beps-plan-oecd-says-20151005-gk1ait.html>



it applies to “significant global entities” – which is a defined term that broadly

encompasses an entity with annual global income (in its own right or as part of a group of

which the entity is a member) of $1 billion or more; and

there is a scheme with the following features:

o a foreign entity makes supplies to non-group customers in Australia;

o activities are undertaken in Australia ‘directly in connection’ with those supplies;

and

o the Australian activities are undertaken by an Australian entity who is associated

or commercially dependent on the foreign entity;

being an anti-avoidance law, there is also a purpose test, although unlike the ‘general’

Part IVA, the threshold test is whether “a person who entered into or carried out the

scheme did so for a principal purpose, or for more than one principal purpose that

includes a purpose” and the “bad purpose” is either a taxpayer (or taxpayers) obtaining a

tax benefit in Australia or reducing one or more of their foreign tax liabilities.

If these conditions are satisfied, then the Commissioner can make a determination under s177F to

cancel the ‘tax benefit’. The determination of the tax benefit requires a determination of a reasonable

alternative postulate21 and then a calculation of the resulting tax benefit by reference to the effect of

the scheme vis a vis the alternative22. The Commissioner suggests in Law Companion Guideline

(LCG) 2015/2 that the alternative postulate in a MAAL situation would be the foreign entity having a

‘notional’ permanent establishment (PE) in Australia, and the resulting tax benefit would be:

“an amount not being included in the assessable income of a taxpayer, and

a taxpayer not being liable to withholding tax.”23

Importantly, the LCG notes that the inclusion of assessable income would be the gross income

‘attributable’ to the PE and any associated expenses would only be able to be taken into account to

reduce the tax benefit by way of compensating adjustment24.

The LCG provides little guidance concerning the critical issue as to the scope of the ‘notional’

(‘pretend’ or ‘fictional’ are other alternative descriptions) PE; we are told that this depends on what is

reasonable and that functions actually located offshore can be part of the hypothecated PE in

Australia25. It is unfortunate that no guidance has been provided in relation to this critical aspect of

the MAAL. In our view this will be the ‘killing field’ in relation to the MAAL (as Australia seeks to tax

21 Section 177CB(3) of the ITAA 1936. 22 Section 177C of the ITAA 1936. 23 LCG 2015/2 24 LCG 2015/2, paragraph 35 25 LCG, paragraph 27



economic activity that actually occurs somewhere else26) and it remains to be seen how the ATO (and

taxpayers) will cope with what could be viewed practically as more than 100 APAs regarding the

attribution of profit to notional PEs or actual subsidiaries/PEs (in the case of groups that have

restructured to avoid the MAAL). The attribution of profits to actual PEs and the negotiation of APAs

are both notoriously difficult and time consuming tasks.

3.3.1. Consequences

As foreshadowed above, the implications of the MAAL on companies which fall within its ambit can be

dire.

The inclusion of gross income on the basis of attribution to a notional PE could be significant – not

least because such a calculation is inherently uncertain given the state of flux regarding guidelines on

PE attribution with a lack of clarity of whether Australia will accept the BEPS revised OECD guidelines

set out in the recently released discussion paper27. However, at this stage, it seems likely that any

expanded definition of PE is unlikely to dramatically increase source country taxation rights. In

addition, we highlight that the OECD guidelines deal with the attribution of profits to actual (cf notional,

pretend or fictional) PEs.

However, in some common structures, the potential to attribute payments of royalties or interest to the

notional PE – with the consequential application of Australian withholding tax – could be even more

significant.

This is demonstrated in the example below.

26 The possibility of unrelieved double taxation (eg where Australia taxes the activities of the notional PE and another country

taxes the actual activities) has been recognised by the ATO. However, it appears that the ATO has no intention of relieving

double tax and suggest taxpayers will need to resort to treaty Mutual Agreement Procedures in these cases. Refer LCG

2015/2, paragraph 37. 27 OECD. (2016, 4 July), BEPS Action 7 – Additional Guidance on the Attribution of Profits to Permanent Establishments,

OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris.



LCG 2015/2 – High Risk Scenario

In this example, the potential consequences of the MAAL applying could be:

Subsidiary B would have a ‘notional’ Australian PE;

Payments from Australian customers would be ‘deemed’ to be attributable to this PE and

would be included as gross income; and

There is a risk that royalty payments from Subsidiary B to Subsidiary A could be ‘deemed’ to

be attributable to the notional Australian PE and therefore could be subject to Australian

withholding tax.

This consequences are magnified by the penalty regime applicable to the MAAL which means that

penalties could be up to 100% of the shortfall amount28.

This seems to be the approach anticipated by the ATO but there are a number of viable alternative

interpretations available (which could, on their own, be the subject of a detailed technical paper). For

example, could it be argued that Australia’s approach to the taxation of PEs29 dictates that only a

minor portion30 of the payments from Australian customers (and associated expenses) would be

attributed to the notional Australian PE31? It would seem critical to agree exactly what functions we

are required to ‘pretend’ are undertaken in Australia by the ‘notional’ PE.

28 Subsection 284-155(3) of the Taxation Administration Act 1953 29 In simple terms, Australia (along with many other OECD countries) has not adopted the so-called “Approved OECD

Approach” or AoA to the taxation of PEs. 30 LCG (paragraph 31) seems to acknowledge this approach in principle: “It is not necessarily the case that all of the gross

income from the sales to Australian customers will attributed to the notional PE, it will depend…” 31 Refer TR 2001/1 (transfer pricing – operation of Australia PE attribution rules)

Subsidiary A

ParentCo

Subsidiary B

AusCoAustralian

Customers

Cost contribution

agreement

Licence

Royalty

Payment and contract

Sales functions that

contribute to bringing

about contracts

Payment Services

Offshore

Australia



3.3.2. Practical responses

Given the significant potential consequences of the MAAL, it is not surprising that many taxpayers

have closely considered whether the MAAL could apply to their affairs.

In many circumstances taxpayers that may otherwise be within the ambit of the MAAL have been able

to obtain comfort that the principal purpose test was not satisfied and therefore that the MAAL did not

apply to their structure. For example, the LCG includes the following example of a low risk structure:

LCG 2015/2 – Low Risk Scenario

In the LCG an emphasis was placed on the fact that the AustCo staff were not involved in forming the

contracts between the Australian customers and ParentCo. It would also be difficult to understand

how the principal purpose test could be satisfied in circumstances where the structure resulted in a

higher global effective tax rate (e.g. where ParentCo is located in a ‘higher than Australia’ tax

jurisdiction).

In circumstances where there may be a risk of the MAAL applying, many taxpayers have sought to

restructure. In many cases, these restructures have, in essence, involved a foreign entity making

supplies directly to a related Australian entity which then performs the functions of a distributor – often

with limited other functions and taking limited risks. The outcome of this restructure is then that the

Australian subsidiary will pay tax based on its net profits – and transfer pricing analysis will be

required to determine the appropriate profit margin of the Australian distributor. As a result of the

restructuring, section 177DA cannot apply because the supply to the Australian unrelated customer is

made by an Australian resident (s177DA(1)(a)(i)).

The ATO has expressed concerns over “interim arrangements in response to the MAAL”. Typical of

most so-called “taxpayer alerts”, Taxpayer Alert (TA) 2016/2 is vague about the features of the

“interim arrangements” which are of concern to the ATO. There are a number of aspects of the TA

which are difficult to follow and likely to be the subject of further debate. For example, a surprising

ParentCo

AustCoAustralian

Customers

Payment

and

contract

Contract

and

product

General marketing

and post-contract

support services

Services

Payment

Offshore

Australia



aspect of the TA is the suggestion that section 177D (the ‘original’ Part IVA) can apply where a

restructure has been taken to avoid the penal consequences of the MAAL. The TA does not explain

how this can be reconciled with the clear intention of the MAAL32 to force companies to do exactly that

(viz restructure their Australian operations).

3.4. The Australian DPT

There is less detail in respect of the potential operation of the proposed DPT, given that the only

public pronouncement thus far is the Discussion Paper released on budget night at 3 May 2016,

Implementing a Diverted Profits Tax33 which is a brief, 20 page document that is unsurprisingly light

on detail. Treasury has received around 20 submissions in relation to the Discussion Paper.

Based on the Discussion Paper, it seems likely that the Australian DPT will be closely modelled on the

UK’s DPT which has been in operation for more than a year. However, differences between the

Australian proposals and the UK law also seem evident. For example, the UK DPT provides

exemptions for loans and tax exempt organisations. In contrast, the Discussion Paper made reference

only to a restriction in relation to loans subject to thin capitalisation. It remains to be seen if such

differences are a deliberate design feature or merely the result of a very rushed release of the

Discussion Paper.

Essentially, the DPT is a punitive targeted anti-avoidance rule (TAAR) which is designed to:

“provide the ATO with greater powers to deal with taxpayers who transfer profits, assets or risks

to offshore related parties using artificial or contrived arrangements to avoid Australian tax and

who do not cooperate with the ATO.”

However, as highlighted in PwC’s submission to Treasury34 in relation to the DPT, it is critical that the

true “target” of the DPT be explained and reflected in the legislation. In particular, the Discussion

Paper sends a confusing signal about whether the DPT is designed to be a further expansion of our

anti-avoidance provisions, an endeavour to change our transfer pricing rules (departing from OECD

standards) or a tool to access information held offshore35.

The punitive aspects of the DPT are:

the 40% tax rate (versus the 30% income tax rate); and

requiring the tax to be paid upfront (based on the Discussion Paper, payment is required 111

days after the Commissioner issues a DPT notice and up to 12 months before the taxpayer

has any rights of appeal).

32 Refer paragraphs 6.63, 6.85, 6.89, 6.123 and the summary of regulation impact of the Explanatory Memorandum to Tax

Laws Amendment (Combating Multinational Tax Avoidance) Act 2015 33 Department of Treasury, (2016, 3 May), Implementing a Diverted Profits Tax, Commonwealth of Australia. 34 http://www.pwc.com.au/tax/assets/implementing-dpt-submission.pdf 35 According to the Discussion Paper the DPT will “increase compliance .. ...with their corporate tax obligations..”...” and

“..encourage greater openness with the ATO…”.



The DPT only applies to ‘significant global entities’ (broadly entities with turnover of greater than $1

billion on a ‘control group’ basis36) and there are essentially two ‘gateways’ which must be satisfied for

the DPT to apply:

the effective tax mismatch test: essentially whether the transaction or series of transactions

between an Australian taxpayer and a non-resident related party results in an increase in the

tax liability of the non-resident which is less than 80% of the corresponding reduction of the

Australian taxpayer’s liability; and

the insufficient economic substance test: this test’s label is essentially a misnomer. The

enquiry required under this test is whether “it is reasonable to conclude that the arrangement

was designed to secure a reduction and the tax reduction exceeds the quantifiable

commercial benefits of the arrangement”37.

The effective tax mismatch rule is an example of the move towards coveting Australia’s neighbours’

tax base. It is difficult to understand a principled rationale for Australia considering a foreign country’s

tax system in determining the appropriate Australian tax outcome.

Further, it is also important to note that the breadth of the ‘effective tax mismatch’ requirement in the

UK DPT is significantly restricted by virtue of the UK’s competitive company tax rate (20% and

heading towards 17% or even less) as compared to Australia’s 30% company tax rate.

Under Australia’s DPT, transactions with countries such as the UK could be caught notwithstanding

that the UK is a listed country for CFC purposes and has sufficiently robust anti-avoidance laws that

Australia is looking to the UK for inspiration!

The DPT is designed to apply to three scenarios:

1) Inflated expenditure scenarios: Essentially where the Australian taxpayer’s expenditure is

‘inflated’ – that is, a non-arm’s length amount. In inflated expenditure scenarios, the default

“Diverted Profits Amount” is an arbitrary 30% of the relevant expenditure;

2) Understated income scenarios: This scenario applies where the Australian taxpayer’s income

is understated as a result of the transaction or series of transactions with a related non-

resident party. This could be due to pricing of a specific transaction, or related to the third

scenario could be due to a reconstruction of the arrangements.

3) Reconstruction scenarios: The discussion paper suggests that the DPT will contain broad

reconstructive powers – providing examples of reconstructing a leasing arrangement to

substitute a hypothetical purchase of the asset and reconstructing a transfer of intellectual

property (IP) to substituting a licence arrangement.

The precise application of these alternatives to different transactions / business structures is difficult to

determine in the absence of more detailed guidance but the reconstruction concept is concerning

36 Subdivision 960-U of the ITAA 1997 37 Department of Treasury, (2016, 3 May), Implementing a Diverted Profits Tax, Commonwealth of Australia, page 9.



particularly given its potential overlap with powers contained in the transfer pricing rules (s815-130)

and general anti-avoidance rules (Part IVA of the ITAA 1936).

However, the rationale for the DPT is likely explained through its punitive nature. The higher tax rate

and the “pay first argue later” nature of the tax is a significant weapon that the ATO will be able to

utilise to enforce compliance. The concept of a compulsory extraction (i.e. the early payment of the

tax) with deferred access to judicial review is novel and concerning.

This raises significant questions in respect of administrative law38 and even constitutional law39 and it

is important that these issues are addressed through future guidance.

Further, protestations that the DPT will only apply to a limited number of unco-operative taxpayers

should be considered from the perspective of Neil Forsyth QC’s prescient article “The bank manager

and the big black dog”40 which is an apocryphal tale outlining the risk of the continuous escalation of

the ambit of anti-avoidance measures. The article is prescient given the apparent difficulty of

reconciling the proposed limited scope of Part IVA such that it:

“ought to strike down blatant, artificial or contrived arrangements, but not cast unnecessary inhibitions on normal commercial transactions”41

with the ATO’s, albeit unsuccessful, attempts to apply Part IVA to the forgiveness of bad debts42.

Accordingly, whilst it is necessary to await further guidance in respect of the details of the DPT, the

Discussion Paper suggests that it is a continuation of the theme of Australia having regard to global

tax outcomes and arguably coveting its neighbour’s tax base.

38 Including for example issues of procedural fairness and natural justice. 39 See for example, section 75(v) of the Commonwealth of Australia Constitution Act.

40 Forsyth QC, N.H.M. (1991),The bank manager and the big black dog, Australian Tax Review, 20 AT Rev 107. 41 Howard J (Treasurer, Commonwealth of Australia), Second reading speech, Income Tax Laws Amendment Bill (No. 2) 1981, 42 See for example, Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd & Ors [2011] FCAFC 49.



4. Implementing the BEPS agenda

4.1. Hybrid mismatch rules

4.1.1. Overview

The hybrid mismatch rules are, similar to the DPT, undeveloped in an Australian context but, again

similarly to the DPT, we have the benefit of UK enacted legislation as well as the OECD’s relatively

detailed recommendations contained in the Action 2 final recommendations43.

The OECD’s report provides a summary of the perceived issue with hybrid mismatches and the

rationale for the amending domestic law and treaty provisions to counteract them, as follows:

“Hybrid mismatch arrangements exploit differences in the tax treatment of an entity or

instrument under the laws of two or more tax jurisdictions to achieve double non-taxation,

including long-term deferral. These types of arrangements are widespread and result in a

substantial erosion of the taxable bases of the countries concerned. They have an overall

negative impact on competition, efficiency, transparency and fairness.”

Essentially the objectives of the hybrid mismatch rules are to counteract differential treatment of the

same transaction in two (or more jurisdictions) where that differential treatment results in:

deduction / no inclusion (D/NI) outcomes – i.e. a deduction allowed in one jurisdiction with no

corresponding income inclusion in the other jurisdiction;

double deduction (D/D) outcomes – i.e. a payment that results in a deduction being allowed in

two (or more) jurisdictions in respect of the one economic payment; or

indirect D/NI outcomes – i.e. payments that are deductible for the payer but which are set-off

by the recipient against a deduction under a hybrid mismatch arrangement elsewhere in the

group.

These outcomes will only generally be caught by the hybrid mismatch rules where the mismatch

outcome arises as a result of the hybridity of the financial instrument or an entity involved in the

transaction. That is, it may still be possible to achieve a ‘hybrid outcome’ without the hybrid mismatch

rules applying in circumstances where the mismatch outcome is not due to the nature of the relevant

instrument or entity (e.g. where the outcome is a result of a specific policy choice by a jurisdiction).

The OECD’s recommendations contain detailed recommendations and examples of the intended

operation of the rules – with 12 specific recommendations44 which are essentially drafted as potential

law.

43 OECD. (2015), Neutralising the effects of hybrid mismatch arrangements, OECD/G20 Base Erosion and Profit Shifting

Project, OECD Publishing, Paris. 44 A further Discussion Draft concerning branch hybrid mismatches is expected in mid-August 2016.



Australia’s response to the recommendations was to, as part of the 2015 Budget, instruct the Board of

Taxation to consult on implementation of the hybrid mismatch rules with terms of reference for the

review released on 14 July 2015. On 3 May 2016, the Government released the Board’s final report

on the Implementation of the OECD Hybrid Mismatch Rules45 which contained 17 recommendations

generally accepting the OECD’s recommendations but with certain provisos and / or

recommendations for further analysis.

Notably, several important considerations regarding the interaction of hybrid mismatch rules with other

areas of the tax law including for example, controlled foreign company (CFC) legislation, tax

consolidation and even esoteric areas such as the provisions for deducting on-paid dividends46 were

not considered in detail in the Board’s initial report and will be areas of detail that will need to be

carefully considered as part of any drafting process for the final hybrid mismatch legislation.

However, even with this limited detail, it is possible to draw some conclusions in respect of the

potential operation of the provisions and important matters to consider. The rest of this subsection

considers this further via some simple examples.

4.1.2. Hybrid payments

It is simplest to explain the operation of the hybrid payment provisions through a basic example.

Example 1.1 of the BEPS paper47 provides the most basic of examples of a hybrid payment.

This could apply in an Australian circumstances where the “loan” between A Co and B Co is, for

example, mandatorily redeemable preference shares (MRPS) which are tax debt in Australia (i.e. “B

Co’s jurisdiction”) but treated as equity in A Co’s jurisdiction and therefore eligible for a participation

exemption.

Example 1.1 – OECD BEPS Action 2 Final Recommendations

45 Board of Taxation, (2016), Implementation of the OECD Hybrid Mismatch Rules, Commonwealth of Australia. 46 Section 46FA of the ITAA 1936. 47 OECD. (2015), Neutralising the effects of hybrid mismatch arrangements, OECD/G20 Base Erosion and Profit Shifting

Project, OECD Publishing, Paris, p175.



The application of the OECD’s recommendation for this example is as follows:

In this respect, some jurisdictions have already implemented “deductible dividend” provisions which

would operate to deny the participation exemption where the other jurisdiction is entitled to a

deduction. The Board of Taxation’s report notes the UK, Japan and the Netherlands as examples of

these jurisdictions48. However, in circumstances where the participation exemption was otherwise

available, if B Co was resident in Australia and Australia implemented hybrid mismatch provisions in

accordance with the OECD recommendations, then Australia should deny the deduction on dividends

paid by B Co. This denial would apply regardless of the fact that B Co and A Co may have otherwise

complied with Australia’s rules relating to cross border financing (e.g. thin capitalisation, TOFA,

transfer pricing, debt/equity, withholding tax etc).

This is the simplest possible example of the hybrid payment provisions and there is significant

complexity in their application in other scenarios – for example in determining whether the mismatch

is caused by the hybrid nature of the instrument or in applying hybrid payment rules for payments on

regulatory capital instruments.

4.1.3. Hybrid entities

The other main causes of hybrid mismatch outcomes is where certain entities have hybrid

characteristics and are treated differently in two jurisdictions. A simple example of this outcome is set

out in Example 3.1 of the OECD BEPS paper as follows.

In an Australian context, the use of Australian companies that are disregarded from their parents

under the US “check-the-box” provisions is a likely example of where this circumstance could arise:

48 Board of Taxation, (2016), Implementation of the OECD Hybrid Mismatch Rules, Commonwealth of Australia.

4. If Country A applies Recommendation 2.1 to deny A Co the benefit of tax exemption

for a deductible dividend then no mismatch will arise for the purposes of the hybrid

financial instrument rule.

5. If Country A does not apply Recommendation 2.1 then the payment of interest will

give rise to a hybrid mismatch within the scope of the hybrid financial instrument rule

and Country B should deny B Co a deduction for the interest paid to A Co. If Country B

does not apply the recommended response, then Country A should treat the interest

payments as ordinary income.



Example 3.1 Disregarded hybrid payment structure

In this circumstance, B Co 1 is treated as an opaque entity in Country B’s tax regime, but is

transparent (and disregarded from its parent) for the purposes of Country A’s tax regime and therefore

the payment from B Co 1 to A Co is recognised for Country B’s purposes but does not exist for

Country A.

The OECD’s recommendation in this circumstance is:

A further complication with the hybrid entity double deduction rule is the ‘dual inclusion income’ rule.

This rule is intended to ensure that B Co 1 won’t be denied interest deductions to the extent it

receives income that is taxed in Country A and Country B. This rule might apply where, for example,

B Co 2 is paying dividends to B Co 1.

Once again, the anti-hybrid countermeasure would apply regardless of the fact that B Co and A Co

may have otherwise complied with Australia’s rules relating to cross border financing (eg thin

capitalisation, TOFA, transfer pricing, debt/equity, withholding tax).

… the fact that B Co 1 is disregarded as a separate entity under the laws of Country B

means that the deductible interest payment that B Co 1 makes to A Co is disregarded

under Country A law and, accordingly, will be caught by the disregarded hybrid

payments rule in Recommendation 3.

7. In the event that Country B does not apply the primary rule under Recommendation

3.1 to the interest payment made by B Co 1, then Country A should include the full

amount of that interest payment in ordinary income under the defensive rule set out at

Recommendation 3.2.



The application of the hybrid mismatch rules to disregarded entities under the US ‘check-the-box’

regime will require careful consideration in both inbound and outbound contexts.

The Board of Taxation’s paper specifically provides the example of the well-known Delaware General

Partnership (DGP) financing as a structure requiring consideration.

4.1.4. Imported mismatch rules

The most complex and potentially far-reaching hybrid mismatch rules relate to the concept of

‘imported mismatch arrangements’. In circumstances where most or all jurisdictions have hybrid

mismatch provisions, then these rules will have less impact (because hybrid outcomes will generally

have been neutralised as they arise in those countries). However, in the currently contemplated

circumstance where Australia is likely to be one of the early adopters of the hybrid mismatch rules the

imported mismatch rule will require careful consideration in relation to virtually all related party cross-

border payments.

Broadly, the imported mismatch rule is:

“designed to prevent taxpayers from entering into structured arrangements or arrangements

with group members in jurisdictions that have not introduced hybrid mismatch rules, to indirectly

shift the tax advantage from the hybrid mismatch to a jurisdiction that has not applied the rules.

This may be through the use of a non-hybrid instrument such as an ordinary loan.”49

That is, it operates so that Australia’s hybrid mismatch rules can operate as the world policeman’

neutralising the ultimate effect of hybrid arrangements even where the hybrid outcome occurs entirely

outside of Australia as a result of the interaction of two foreign jurisdiction’s tax rules.

In order to understand the complexity, and potentially broad ramifications of this proposal, it is worth

considering an example from the OECD’s BEPS paper which was also considered in Cohen, James,

Rhodes and Raphael’s recent paper on similar matters50:

49 Board of Taxation, (2016), Implementation of the OECD Hybrid Mismatch Rules, Commonwealth of Australia. 50 Cohen R., James L., Rhodes P. and Raphael K, Business Models in the current BEPS environment – do you need to

change?, The Tax Institute, June 2016.



Example 8.7 Direct imported mismatch rule

As can be seen from this example, payments on ordinary debt instruments that are in no way hybrid

instruments and which do not involve hybrid entities could potentially be denied deductions to the

extent which these payments could ultimately fund a hybrid payment (in this case the C Co to A Co

payment).

Further, determining whether the imported mismatch rule could apply requires:

a) knowledge of the ultimate holding and financing structure in forensic detail;

b) knowledge of other jurisdictions’ tax law to determine whether a hybrid outcome has resulted;

and

c) the ability to trace funds so as to be able to attribute Australian payments to the ultimate

hybrid outcome.

Fortunately the Board of Taxation has realised the practical difficulties of this provision and has

recommend that:

“careful consideration should be given to the legislative drafting process to ensure that the

interpretation and compliance issues identified with section 974-80 are not replicated in the

imported mismatch rule. The Board also recommends that detailed administrative guidance be

provided by the Commissioner to assist both taxpayers and the ATO in applying this rule

(particularly around the tracing of funding and apportionment of deductions).”

The devil will ultimately be in the detail of how these particular provisions are drafted – particularly

where Australia is acting in advance of the majority of the world in respect of hybrid mismatches.

4.1.5. Hybrid mismatch rules – conclusion

The hybrid mismatch rules will undoubtedly increase the complexity of conducting cross-border

transactions globally. The, arguably, laudable ambition of mitigating the circumstances of double non-

A Co

C Co

B Co

E Co

$200Hybrid

payment

$100 interest

Description

In this example, C Co has made a hybrid payment to A Co. Four separate non-hybrid interest payments are made elsewhere in the group by E Co, F Co, G Co and H Co. The example assumes that Countries D, E and F all adopt the imported mismatch rule and that the other Countries C, B, G and H do not.

The non-hybrid interest payments made by the other companies in the A Co group are all subject to potential disallowance, but only up to the amount of the hybrid mismatch payment. The question posed in this example is: which country gets to disallow the interest payment made by its local subsidiary?

The Action 2 recommendations suggest starting with the country with the imported mismatch that is most direct, but only to the extent that country adopts the imported mismatch rule.

In that case, Country D gets to disallow the full 200 interest payment to C Co, which matches the amount of the hybrid payment by C Co. Countries E and F would not get to disallow any interest payment because the hybrid mismatch has been neutralized by a disallowance to a less indirect borrower.

If Country D didn't implement the Action 2 recommendation noted above, Countries E and F could disallow the full $100 interest payment in each country, unless Countries G and H also implemented the Action 2 recommendation, in which case they could each disallow a proportionate amount of their payments—in that case, since in total $400 of deductible payments would be implicated with only a $200 hybrid mismatch, each country could disallow $50 of the $100 interest payment.

D Co

F Co G Co H Co

$100 interest

$100 interest

$100 interest



taxation and / or stateless income will need to be balanced against the cost of compliance and the

risks of double taxation that are created. This is particularly the case for a capital importing nation

such as Australia.

The detail of the implementation of all hybrid mismatch measures will be particularly important, and

this is only exacerbated in respect of complex measures such as the imported mismatch rule.

Improperly applied, the imported mismatch rule could increase uncertainty for taxpayers and decrease

the attractiveness of Australia as a place to do business. Even properly applied, the policy

justification for penalising Australian taxpayers for outcomes permissible under the laws of foreign

jurisdictions where the relevant transactions have limited nexus to Australia is debateable – however,

it is likely to be more productive to ensure efficient implementation of these measures rather than to

continue to debate their appropriateness.

For taxpayers, the practicalities of implementation will be of utmost importance. In this respect, some

of the key issues, based on our experience in other countries, will include:

the interaction of the hybrid measures with other areas of Australia’s tax law, including debt

equity rules, participation exemptions, tax consolidation, TOFA, section 46FA and CFC rules

– ensuring that there are clear ordering provisions and that all ‘collateral’ issues are

understood and addressed;

clear administrative guidance – particularly in respect of measures which require tracing or

design tests such as the imported mismatch rules;

adequate time to understand the proposed rules (the Government has adopted the Board of

Taxation proposal which requires legislation to be available at least 6 months before any

rules become effective); and

clear legislative or administrative confirmation that taxpayers will be free to restructure to

avoid the impact of any hybrid mismatch rules.



5. Conclusion

The purpose of this paper has been to provide a brief survey of recent Australian international tax

developments and to evaluate them against their theoretical basis as well as the practical

implications.

In terms of purpose and theory, as well as practical effect, the measures considered in this paper will

likely have the short-term effect of increasing Australia’s share of revenue base from cross-border

related party transactions.

This includes an aggressive approach to the transfer pricing outcomes of cross-border related party

financing, unilateral integrity measures such as the MAAL and DPT, as well as the proposed

implementation of the OECD’s hybrid mismatch provisions ahead of many other OECD jurisdictions.

It is important to note that, unlike the UK, it appears likely that these ‘integrity measures’ will not be

accompanied by a reduction in company tax rate or by other measures designed to increase the

competitiveness of the Australian tax regime. At a macro-level, it remains to be seen whether

measures such as those discussed in this paper and combined with a lack of broader tax reform,

could end up damaging Australia’s international competiveness.

More practically, it is important for taxpayers and advisers to be aware of the individual and collective

impact of these measures in evaluating proposed transactions as well as existing business structures.

Further, given the changing tax environment, it will be increasingly important to rigorously analyse and

document technical positions and evidentiary support, as well as, where appropriate, proactively

engaging with the ATO in order to achieve as much certainty as possible in respect of the tax

outcomes of international dealings.

In the longer term, there is a real question about the impact of these ‘reforms’ on Australia’s tax

collections and economy more generally. In simple terms, if Australia is a leader in terms of changing

international tax rules or being more adventurous in terms of transfer pricing rules, there is every

chance that other countries will catch up. This will inevitably lead to more instances of double taxation

and disputation which could be a drag on international investment and growth.

It does not take volumes of economic theory to appreciate that any such drag is more likely to impact

the receipients of that capital than it is the owners. However, all participants in the corporate, financial

and political system in Australia need to accept that what might be sound policy, has not necessarily

accepted by the most important actors in the system ... the voter. Whether economically or fiscally

responsible, the populist sentiment is wining the battle in the black and white text in our tax legislation

that once sat on our desks. Ironically, for a growing many of us that same legislation sits in a cloud

that we access periodically from our IPad.

The IT geek has had a bigger impact on the tax profession than the profession has had on Joe

Average's perspective on tax policy in Australia. Is it no wonder then that we have not convinced Joe

Average of the fundamental maxim of global tax - "thou shalt not covert they neighbour's tax base ...

lest they should covert your's".

We have only scratched the surface and there is no doubt that these themes will be developed for

years to come!

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