On 22.4.16, the Senate Economics References Committee tabled Part 2 of it’s tax avoidance report – Part 2: Gaming the System. The following extracts give insight into the thrust of the report.
[APH website] [LTN 76, 22/4/16]
The first extract gives the background to Part 2 of its report.
Chapter 1 – Background
First report on corporate tax avoidance
1.7 Given the broad scope of the terms of reference and the timing of the multilateral OECD/G20 initiative on base erosion and profit shifting, the committee resolved to report on the initial work of the inquiry and the four public hearings that were held in April 2015. The interim report examined the evidence presented to the committee by some of the largest multinational corporations operating in Australia. It concluded that, despite the recent efforts of successive governments to address corporate tax avoidance, significant concerns persist about multinational corporations not paying an appropriate amount of tax in Australia relative to their activities here.
1.8 The interim report supported the ambitious OECD/G20 initiative to develop a coordinated response to base erosion and profit shifting but also noted that this initiative should not prevent the Australian Government from taking unilateral action.
1.9 The interim report made 17 recommendations over four areas:
- evidence of tax avoidance and aggressive minimisation;
- multilateral efforts to combat tax avoidance and aggressive minimisation;
- potential areas of unilateral action to protect Australia’s revenue base; and
- the capacity of Australian government agencies to collect corporate taxes.
1.10 The recommendations of the interim report focused primarily on increasing the transparency of corporate tax affairs and ensuring that tax administrators could access the information required to identify and act on aggressive tax minimisation and avoidance. The committee continues to strongly support all of the 17 recommendations made in the interim report.
1.11 The committee tabled the interim report, Part I—You cannot tax what you cannot see, on 18 August 2015. The report is available on the committee’s website.
Second report on corporate tax avoidance
1.12 In this second report on corporate tax avoidance, the committee continues its consideration of the importance of transparency with particular emphasis on transfer pricing and the secrecy surrounding this activity. The committee briefly touches on exemptions from general purpose accounting. It also looks at tax minimisation strategies including excessive debt loading and avoiding permanent establishment in Australia.
1.13 Although the committee has delved into the use of tax havens as a means of avoiding tax, recent revelations emanating from a law firm operating out of Panama have enlivened commentary about this practice.
Use of overseas tax havens by Australians
1.14 At the beginning of April 2016, an international coalition of media outlets published their findings based on extensive investigation into the offshore financial dealings of many individuals and companies throughout the world. This investigation was based on the disclosure of a vast volume of documents, known as the Panama Papers, which came from an anonymous source.
1.15 The Australian Taxation Office (ATO) has indicated that it has received data in relation to the Panamanian law firm at the centre of these revelations, which contain the names of ‘a significant number of Australian residents’. At this time, 4 April 2016, the ATO had identified over 800 individual taxpayers and linked over 120 of them to an associate offshore service provider located in Hong Kong.
1.16 In light of information coming out of the Panama Papers and the ATO’s investigations, the committee will defer further consideration on the use of tax havens as a means of avoiding and, in some cases, evading tax in Australia, until there has been sufficient time to evaluate the data.
Project DO IT
1.18 It should be noted that the ATO embarked on a concerted effort to stamp out tax evasion using offshore accounts. In October 2014, the ATO launched Project DO IT: disclose offshore income. This project, which ended on 19 December 2014, offered reduced taxes and penalties for people who voluntarily disclosed offshore income and assets. It provided an opportunity for any Australian who had engaged in unreported offshore financial activities to disclose their activity. According to the ATO, under this project more than 5800 Australians brought $600 million in offshore income and $5.4 billion in assets back into the Australian economy with the ATO raising more than $245 million in additional tax revenue liabilities for the community.
1.19 The ATO has continued its commitment to stop offshore tax evasion. At the end of 2015, it announced that it was ramping up its focus on this type of activity. It noted that:
As part of a new wave of action to combat offshore evasion which has seen the ATO obtain more than 5000 client names from wealth management firms and compile a list of 100 advisers and promoters operating globally that have a direct link with people who may have evaded taxes.
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The intelligence picture we now have has been built from information taxpayers disclosed under Project DO IT about the adviser who put them into the offshore arrangements, data mining and client records seized from advisers in transit…
This next extract is the heart of Part 2 of this report: The ‘persistent problem‘.
Chapter 2 – A persistent problem
Increasing transparency remains pivotal
2.5 A consistent theme throughout this inquiry has been the lack of public information about company tax affairs and an unwillingness of certain companies to divulge this information. For example, a number of companies attended hearings for the inquiry but could not, or would not, provide even basic tax information to the committee about their Australian operations.
Transfer pricing
2.23 Australia’s transfer pricing rules are modelled on the OECD guidelines for the trade of goods and services between related entities of a multinational corporation that operate in different jurisdictions. …
2.24 The transfer pricing rules effectively allow multinationals to charge Australian consumers whatever the market will accept and then shift the profits out of the country through transfer pricing. In these circumstances, the Australian subsidiaries are remunerated only for, and pay corporate tax on, the value added in the role as a distributor and/or facilitator of goods and/or services to Australian consumers. Evidence provided to the committee indicated that the profits, and thus tax paid, from these distribution activities represent only a fraction of total Australian revenue.
2.25 In relation to the strategies used by ‘big pharma’ to minimise their tax obligations, there would appear to be a deliberate strategy of ‘plausible deniability’. The committee was dumbfounded to learn that the executives of a number of multinational pharmaceutical companies knew almost nothing, if anything at all, about the transfer prices of identical products supplied to other international subsidiaries. For example, the Managing Director of Sanofi Australia indicated as much when questioned about whether he benchmarked the cost of goods in Australia to the cost of goods paid by subsidiaries in other jurisdictions. Similarly, the General Manger of GlaxoSmithKline Australia and the Director of Market Access, External Affairs, Commercial Innovation and Legal at AstraZeneca Australia also provided responses indicating their ignorance of purchase prices in other jurisdictions.
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2.35 While OECD transfer pricing principles may be the accepted practice, the evidence provided to the committee across a variety of industries confirms that the current transfer pricing regime does not serve Australia well from a tax revenue perspective. Effectively companies that do not have standardised pricing across jurisdictions can charge whatever the market will bear and then back out the profits through transfer pricing. Allowing multinationals, in effect, to arbitrarily attribute value between countries provides them with opportunities to price gouge Australian consumers while, at the same time, reducing the tax liabilities of their Australian subsidiaries.
2.36 Recent legislative changes and proposed Base Erosion and Profit Shifting (BEPS) recommendations will not radically change how transfer pricing principles are applied and, as such, it would be reasonable to conclude that foreign-based multinationals will continue to avoid paying tax that reflects the value of the business activities they conduct in Australia.
2.37 Transfer pricing could become even more important as companies restructure and create ‘permanent establishments’ in Australia in order to avoid being captured by the multinational anti-avoidance law (MAAL) which is effective from 1 January 2016. This development is particularly relevant to ensure that multinationals involved in the digital economy account for earnings in the jurisdiction where the activity occurs.
2.38 The nature of the digital economy provides opportunities for aggressive tax minimisation by allowing multinationals, such as Google, Microsoft, Uber and Airbnb, to deliver services using software platforms that can be located on the other side of the world. For example, Uber and Airbnb, based in Ireland and the Netherlands respectively, provide a platform for the exchange of services between Australians in Australia; yet the financial transactions associated with these services are undertaken in offshore jurisdictions and the Australian subsidiaries are reimbursed for expenses with a margin added on.
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2.40 The committee does not accept the argument that activities within Australia represent only a small proportion of overall value creation, and considers that current transfer pricing principles need to be fully explored and, where necessary, redrafted to ensure that transfer pricing cannot be manipulated to the detriment of Australian tax revenue. For example, if Australian consumers are paying higher prices for goods and services than a comparable product in other countries, then arguably this represents a value creation activity in Australia. Rather than just paying tax on a relatively small net profit margin for distribution services, corporate income tax liabilities could be calculated on the difference between the Australian price and the cost of supply to other countries.
Debt‑related deductions
2.41 Another questionable practice employed by some companies that appeared before the committee was the use of internal loan arrangements to create debt-related deductions, thereby manufacturing opportunities to shift pre-tax profits out of Australia. For example, if multinational subsidiaries in low tax jurisdictions provide loans to subsidiaries in high tax jurisdictions, the interest payments can be tax deductible in the high tax jurisdiction while the interest payments received in the low tax jurisdiction are taxed at a lower rate.
2.42 In Australia, the most widely publicised case relating to multinational debt‑related deductions involves a loan between Chevron subsidiaries. Chevron Australia has been engaged in a protracted disagreement with the ATO over interest related payments (primarily the rate of interest charged) on loans between the Australian subsidiary and affiliates based in the United States.
2.43 Debt-related deductions span a number of areas of the corporate tax regime, including thin capitalisation, hybrid mismatching and transfer pricing. One frustration for the committee was the very limited information that was publicly available which outlined ‘real world’ examples of aggressive tax minimisation using debt-related deductions in an Australian context. Hence, it was difficult for the committee to get an appreciation for the size and scope of this problem.
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Australian Taxation Office resourcing
2.47 This inquiry has provided a unique opportunity for the ATO and the Commissioner of Taxation to discuss multinational tax avoidance and aggressive minimisation in public forums. Indeed, the Commissioner has always made himself, and relevant staff, readily available to answer the committee’s questions and appear at hearings.
2.48 The Commissioner himself has recognised the main impediments to addressing corporate tax avoidance and aggressive minimisation:
I have said: ‘Right now, I don’t think it’s the law; it’s the cooperation of the companies; it’s the ability to get things through the judicial system in a reasonable way; and it’s a change in attitude on our behalf.’
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Conclusion
2.57 The committee notes the observation by the Commissioner of Taxation that the major obstacle to preventing multinationals exploiting Australia’s taxation regime was not the law but the cooperation of the companies and the ability to get processes through the judicial system in ‘a reasonable way’. He spoke of the way the companies ‘push the envelope’ and how they think they can ‘stooge’ the ATO. As amply demonstrated in the extracts provided in this chapter, the committee gained a similar impression of the multinational companies that gave evidence—their contrariness in answering questions, propensity to obfuscate, and, in some cases, simply not answering or deliberately misunderstanding the question.
2.58 While the committee recognises the determined stance the ATO is now taking, it is of the view that there is more scope for the government to assist the ATO in pursuing its mission to stop multinationals from gaming the system and ‘stringing the ATO along’. The committee is particularly concerned about the resources available to the multinationals and their ingenuity in exploiting any loopholes in the laws. The difficulty for the government and the ATO is to match this ingenuity and have the resources ready to challenge the companies.