Diverted Profits Tax moving forward

Diverted Profits Tax moving forward

Peter Madden and Liam Delahunty, International Tax Specialists, discuss the implications of the proposed Diverted Profits Tax for global companies.

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On 29 November 2016, the Australian Treasury released Exposure Draft (ED) legislation and an accompanying Explanatory Memorandum (EM) in relation to the proposed Australian Diverted Profits Tax (DPT).

Application

In summary, the DPT is intended to provide the Australian Taxation Office (ATO) with additional powers, within the general anti-avoidance regime framework, to deal with global groups who have “diverted” profits from Australia to offshore associates, using arrangements that have a “principal purpose” of avoiding Australian income or withholding tax. The DPT can apply to both Australian inbound and outbound groups, where the global group has annual global income of A$1 billion or more.

If the DPT applies, income tax will be payable on the amount of the “diverted profit” at a rate of 40 percent. There appears to be a risk that the Mutual Agreement Procedure in Australia’s tax treaties would be unavailable where DPT applies – in which case unalleviated double taxation would result.

Exceptions

Importantly, the DPT will not apply where it is reasonable to conclude one of the following exemptions apply:

  • Exception 1: The $25 million turnover test – the DPT will not apply where the turnover of the taxpayer and other Australian entities in the same global group does not exceed AUD$25 million for the year (provided no income is artificially booked offshore).
  • Exception 2: Sufficient foreign tax test – the DPT will not apply if, in relation to the scheme, the increase in the foreign tax liability is equal to or exceeds 80 percent of the corresponding reduction in Australian tax. Having a transaction between Australia and a high-taxed jurisdiction does not automatically mean the DPT will not apply; it may well be necessary to trace through the high-taxed entity to other associates involved in the supply chain that are based in low tax jurisdictions.
  • Exception 3: Sufficient economic substance test – the DPT will not apply if the income derived as a result of the scheme reasonably reflects the economic substance of the entity’s activities in connection with the scheme, having regard to recent Organisation for Economic Co-operation and Development (OECD) transfer pricing guidance. Documenting this will likely be a key area of focus for many groups.

Next steps

It is noteworthy that the ED and EM are open to a condensed 3.5 week consultation period in the run-up to Christmas. Although there have been some relatively minor changes since the initial Consultation Paper from May, the core elements of what the DPT is targeting remain unchanged.

Notably, many of the submission points that were made in respect of the initial Consultation Paper do not appear to have been addressed. Therefore, and given this legislation is unlikely to encounter opposition in the Senate, the final legislation may well be similar in key respects to the current ED.

As the DPT is to be effective for income years commencing on or after 1 July 2017, its enactment will likely leave a limited window for groups to consider (and where necessary address) the potential application of DPT.

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