When introducing the draft legislation for the Diverted Profits or so-called “Google Tax”, Federal Treasurer Scott Morrison claimed it would:
…reinforce Australia’s position as having amongst the toughest laws in the world to combat corporate tax avoidance.
Australia is the second country to introduce this type of tax, after the UK in April 2015. So in that sense, Australia is (almost) leading the world.
The benchmark rate used to determine whether the tax should be applied, at 24%, might also add weight to the claim that Australia’s law is the world’s toughest. It will cover countries like Singapore and Ireland, but also ironically the UK, which has a standard company tax rate of 20% (scheduled to be reduced to 17% by 2020).
But even if the law appears to be the toughest, we will have to see it in practice to tell. The new law has a couple of critical concepts that are new and untested, namely the principal purpose test and the economic substance test.
Both tests require a detailed examination of the facts and circumstances of the multinational corporation in question. Experience with the existing general anti-avoidance provisions suggests that it is difficult to predict how the Australian Taxation Office (ATO) will implement the law and, more importantly, how the courts will interpret and apply these tests.
However, the government should be commended for taking this bold step to strengthen the tax law in the face of strong opposition on many fronts. While it may not be surprising that the business community in general is not in favour of this tax, the OECD and some countries (in particular the United States) have expressed reservations about the proposal. They argued that this kind of unilateral action by a country will work against the international consensus reached in the OECD’s base erosion and profit shifting (BEPS) project.
The determination of the UK and Australia to implement the tax anyway may be partly due to political pressure from public opinion. But it could also stem from the realisation that the OECD’s recommendations in its BEPS project may not be always effective in dealing with international tax avoidance by multinationals.
What the Google Tax will do
The Google Tax will be effective from July 1, 2017. It will work along side the Multinational Anti-Avoidance Law (MAAL), which came into force on January 1 this year.
The MAAL has a relatively narrow scope, focusing on company tax structures that are designed to avoid having a taxable presence in Australia – similar to those of Google and Microsoft. In contrast, the Google tax will have a wider scope and will potentially be a more powerful weapon for the ATO to combat tax avoidance by multinationals.
It mostly follows the structural design of its counterpart in the UK. It will apply to large multinationals with annual global turnover of at least A$1 billion, unless their turnovers in Australia are not more than A$25 million and thus represent relatively small tax avoidance risks.
A multinational that exceeds these turnover thresholds may be subject to the tax if, among other things:
- It has entered into a scheme to divert profits from Australia;
- The diverted profits are subject to an effective foreign tax rate of less than 24%;
- The tax structure lacks economic substance; and
- The principal purpose of the scheme is to obtain a tax benefit in Australia.
Apple as an example of how this tax works
Apple’s tax structure is a useful case study in how the tax will work. The ATO may have a good basis to argue that Apple has entered into a scheme to divert profits from Australia by shifting income to Ireland, where the profits booked there are not subject to any tax at all.
If the ATO can successfully argue that the structure lacks economic substance (for example, the Irish subsidiary has no employees, yet was found by the European Commission to have booked more than 100 billion euros (A$143 billion) in profits over 10 years since 2003) and the principal purpose of the structure is to obtain a tax benefit in Australia, then the tax may apply.
If the tax applies, a multinational will have to pay tax on the diverted profits at 40%, a penalty rate higher than the standard 30% company tax rate. This is a deliberate policy to discourage these companies from engaging in tax-evasion structures.
The draft legislation also incorporates the “pay first, argue later” policy to deter multinationals further from entering into aggressive tax-avoidance arrangements. If the ATO determines that a multinational is subject to the tax, the company must pay the tax within 21 days, and in general cannot appeal to the court until a 12-month review period expires. This policy, which is a carbon copy of the similar UK law, is another powerful measure to discourage these companies from avoiding tax in the first place.
The ATO can also determine whether a multinational is subject to the DPT based on information available to the Tax Commissioner. In other words, the onus is on the company to prove that it should not be subject to the DPT.
This point is very important in practice, as some multinationals may refuse to cooperate with the ATO and not provide necessary information about their tax arrangements. The draft legislation is designed to address this issue.
Of course, this Diverted Profits Tax alone will not be sufficient to cope with all forms of international tax avoidance structures. For example, stronger specific anti-avoidance rules are required to deal with BEPS using interest deductions.
However, the introduction of the tax is a welcoming move by the government in the war against tax avoidance by multinationals.
Authors: Antony Ting, Associate Professor, University of Sydney