TA 2016/11 –defeat the MAAL (s177DA) by inserting a partnership with an Australian minority partner (an ‘Australian entity’) as the distributor with the old foreign supplier as its agent (no change in operations)

On 15.9.16 the ATO issued a further Tax Alert: TA 2016/11 about arrangements is concerned will be ineffective to defeat the Multinational Anti-Avoidance Law (MAAL) in s177DA of the Income Tax Assessment Act 1936 (ITAA36).

This is the third TA on MAAL avoidance this year, after TA 2016/2 about foreign and Australian entities swapping roles [TT-TM] and TA 2016/8 about GST consequences of MAAL avoidance structures [TT-TM].

The Scheme

The scheme that has come to the ATO’s attention involves interposing an entity described as a partnership between the foreign entity originally making supplies to Australian customers and the Australian customers. The partnership has one resident corporate partner with a minority interest in the partnership, therefore purporting to characterise the partnership as an ‘Australian entity’ for the purposes of the MAAL. Agreements entered into purport to make the partnership the distributor of the products or services and the foreign entity its agent. The arrangements have little, if any, commercial basis and no changes are made to the underlying functions.

Under the restructuring arrangement:

1. The multinational group forms an entity described as a partnership. The partnership has two newly incorporated companies as partners; one Australian resident partner and a non-resident partner. The resident partner holds a minority interest in the partnership.
2. The resident partner does not have the right to be involved in the management or conduct of the business of the partnership.
3. The partnership agreement specifies all management decisions regarding the partnership will be conducted outside Australia.
4. Further complexity is introduced into the existing structure through the creation of additional entities; the transfer of legal rights and obligations; changes in contractual relationships with customers; and additional intra-group services agreements.

• For example, the existing foreign entity that previously made supplies to, and derived income from, Australian customers enters into a distribution agreement with the partnership to transfer the right to distribute the products or services to Australian customers to the partnership, thereby purporting to attribute profit to the partnership.
• At the same time, the partnership enters into an agency agreement that purports to authorise the existing foreign entity to continue to make supplies to Australian customers as an agent of the partnership. This is intended to give full effect to the distribution agreement.

5. There is no material change to the operational activities undertaken by the group in making supplies to Australian customers.

The MAAL

177DA(1)   Without limiting section 177D, this Part also applies to a scheme if:

(a)      under, or in connection with, the scheme:

(i)      a foreign entity makes a supply to an Australian customer of the foreign entity; and

(ii)     activities are undertaken in Australia directly in connection with the supply; and

(iii)    some or all of those activities are undertaken by an Australian entity who, or are undertaken at or through an Australian permanent establishment of an entity who, is an associate of or is commercially dependent on the foreign entity; and

(iv)     the foreign entity derives ordinary income, or statutory income, from the supply; and

(v)      some or all of that income is not attributable to an Australian permanent establishment of the foreign entity; and

(b)     it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a principal purpose of, or for more than one principal purpose that includes a purpose of:

(i)      enabling a taxpayer (a relevant taxpayer ) to obtain a tax benefit, or both to obtain a tax benefit and to reduce one or more of the relevant taxpayer’s liabilities to tax under a foreign law, in connection with the scheme; or

(ii)     enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit, or both to obtain a tax benefit and to reduce one or more of their liabilities to tax under a foreign law, in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers; and

(c)      the foreign entity is a significant global entity for a year of income in which the relevant taxpayer, or one or more other taxpayers, would (but for this Part):

(i)      obtain a tax benefit; or

(ii)     reduce one or more of their liabilities to tax under a foreign law;

in connection with the scheme.

Ostensible Tax Effect

If the partnership is successfully made the distributor of the products, then the inclusion of an Australian entity as one of the partners does preclude s177DA applying because the supplier is not a ‘foreign entity’ (as required by s177DA(1)(a). This follows from the chain of definitions of ‘foreign entity’ (in s177A(1) & s995-1), which ultimately exclude an ‘Australian entity’, which, in turn, is defined (in s995-1; s317(1) and s336(a)) to include an ‘Australian partnership’. And ‘Australian partnership’ is further defined (in s337) to include a partnership that includes an ‘Australian entity’ as a partner.

Additionally, the ATO says, taxpayers claim that:

1. only the Australian resident partner would return their share of partnership net income in Australia [presumably because the source of the income from sale of the product is foreign and the non-resident is not assessed on foreign source income]; and
2. there is no GST payable on supplies the partnership makes to Australian customers [depending on whether it’s a supply of a tangible or intangible – see s9-25 of the GST Act].

The ATO’s concerns about these claimed effects

The ATO is concerned the arrangements:

1. are structured in an artificial and contrived manner solely to avoid the application of the MAAL and are not aligned with the MAAL’s policy intent and commercial reality
2. do not involve any substantive changes to the underlying business carried on by the multinational group in Australia and the functions undertaken by its constituent entities in relation to the supplies to Australian customers pre- and post-MAAL

• are not effective in avoiding the MAAL’s application.

 

The ATO says that some of the main technical issues that arise include, whether:

1. the partnership is effective at law. [This is probably a reference to the need for a general law partnership to carry on business, which it will if it is actually the supplier. However, it is contrived to have the previous supplier contract to (ostensibly) transfer the distribution rights to the interposed partnership, only to have that partnership then appoint the vendor to be its agent – so that nothing need change. This does sound like a real weakness – if for nothing else, for the operation of the general anti-avoidance provisions in s177D and possibly also ‘sham’.]
2. the transfer of legal rights and obligations is effective. [With so much riding on the interposed partnership being the actual supplier, with no external way of verifying it, it is right to scrutinize these documents carefully to see if they do what they say.]
3. the new intercompany agreements achieve the purported outcome of the restructure and whether the parties actually act in accordance with these terms. [Failure to actually do what the documents say is a very telling factor in sustaining allegations of sham.]
4. the enterprise has a permanent establishment in Australia. [I’m not sure what the significance of this is – double tax treaty or the s177DA(1)(a)(v) requirement that ‘some or all of that income is not attributable to an Australian permanent establishment of the foreign entity’ or otherwise.]
5. section 177DA applies to the arrangement. [The MAAL could still apply if the contracts were not effective (to make the interposed partnership the supplier).]
6. section 177D applies to the arrangement. [If the MAAL were defeated by a technicality, which was artificial in nature, the arrangements may still attract the operation of the general anti-avoidance provision in Part IVA (s177D).]
7. GST is payable on the supplies made after the restructure. [This may depend on the nature of the thing supplied, if all the restructure elements were effective, but then it may still be subject to GST anti-avoidance provisions (Div 165 of the GST Act).]

[ATO website – TA 2016/11] [LTN 179, 15/9/16]