On Wednesday 10 Aug 2016, the ATO issued TA 2016/7 (the first of 3 on that day).

It relates to arrangements they have seen of Australian company groups that have elected to consolidate, for Australian income tax purposes, with one of those companies having an off-shore Permanent Establishment (PE). There is a tension here between transactions being ignored for Australian income tax purposes, under the single entity rule (s701-1 of the ITAA97) and the basis on which profits attributable to the foreign PE are calculated (as that income should be derived as ‘non-assessable non-exempt’ (NANE) under s23AH of the ITAA36.

This diagram is used in the TA as an example of the type of arrangement the ATO is reviewing.

type of arrangement being reviewed

 

The ruling expands on the elements of this structure, which the reader can refer to in the TA itself (see link below).

The ATO states its concerns as follows:

  1. We have concerns that, in adopting this arrangement, consolidated groups may be understating their assessable income; and/or
  2. incorrectly claiming deductions for expenses incurred in deriving non-assessable non-exempt income for Australian income tax purposes.

Specifically, we are concerned consolidated groups are:

  • Failing to return sufficient assessable income in Australian consolidated income tax returns, either by attributing¬†excessive amounts of income to the offshore PEs so as to treat all of that excessive amount as non-assessable non-exempt income under section 23AH of the ITAA36. Or the Group might ignore too much of the intra-group receipts, in circumstances where other members of the consolidated group or offshore related entities have made a significant contribution towards the business carried on, at or through the Offshore PE.
    • This may be through a misunderstanding of the requirements of section 23AH and the consolidation provisions in Part 3-90 of the ITAA97, understood in the context of a statutory scheme that includes the arm’s length (transfer pricing) rules in section 136AE(4) of the ITAA36 and Subdivision 815-C of the ITAA97.
    • It may involve a misunderstanding of what it means for income to be derived by a company in carrying on a business at or through a PE. While identifying that a PE exists and undertakes certain activities on behalf of Australian SubCo3, is an essential step in the analysis, it does not, of itself, mean all of the income Australian SubCo3 derives has been derived at or through the Offshore PE.
    • It may also involve a misapplication of the deemed source rules included in some of Australia’s double tax agreements for the purpose of ensuring Australia, as the country of residence, does not double tax business profits that have been taxed in another jurisdiction in accordance with those agreements.
  • Incorrectly claiming deductions for expenses related to the gaining or producing of non-assessable non-exempt income.

If the tax effect of these arrangements is as suggested, the result would be the double non-taxation of income; that is, income would be sheltered from tax in the foreign jurisdiction (by reason of the foreign jurisdiction allowing a deduction for the intra-group expense) which is not brought to tax in Australia (by reason of the intra-group receipt being ignored under the single entity rule in section 701-1 of the ITAA 1997). This would be an anomalous outcome and inconsistent with the purposes underlying the consolidation provisions and Australia’s double tax agreements.

In some cases, where deductions are claimed in Australia for external expenses relating to the Offshore PE’s activities, the purported tax effect is not just double non-taxation of this income, but, in fact, tax relief against other domestic activities.

Arrangements which result in the double non-taxation of income or anomalous outcomes may also contain features which would attract the application of the general anti-avoidance rules in Part IVA of the ITAA 1936.

[ATO website – TR 2016/7] [LTN 153, 10/8/16]