Three takeaways from the proposed reforms on multinational tax integrity and transparency

The new Federal Government’s 2022 election policy platform included a multinational tax integrity package designed to address tax integrity concerns pertaining to multinational enterprises (MNEs) and improve transparency through better public reporting of MNEs’ tax information. The Government has released a consultation paper outlining its proposed reforms.

Three takeaways from the paper are:

1. a renewed focus on Thin Capitalisation Rules, including limiting interest deductions for MNEs in line with OECD recommendations;
2. mandatory reporting of material tax risk to shareholders; and
3. requirements for tenderers for Australian government contracts to disclose their country of tax domicile.

1. New Thin Capitalisation Rules – changes to safe harbour

The proposed new Thin Capitalisation Rules would limit interest deductions for MNEs in line with the OECD’s recommendations under Action 4 of the Base Erosion and Profit Shifting (BEPS) program. This was spurred by concerns outlined by the OECD

The current Rules require entities to calculate their adjusted average debt and compare it to the maximum allowable debt prescribed by the Rules. Currently, the maximum allowable debt is the greatest of:

• the safe harbour debt amount: 60% of the average value of the entity’s Australian assets
• the arm’s-length debt amount: the amount of debt that could have been borrowed by an independent party carrying on the same operations as the Australian entity; or
• the worldwide gearing debt amount: whereby an entity’s Australian operations can be geared up to 100% of the gearing of the worldwide group to which the Australian entity belongs.

The Government is considering a shift from an assets-based safe harbour test to an earnings-based, “fixed ratio” rule to discourage perceived excessive gearing, with the recommended approach being, to limit net interest deductions to 30% of Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA). This is to ensure that an entity’s interest deductions are directly linked to its economic activity and its taxable income.

Most Australian entities that are subject to the Rules currently apply the safe harbour test. While the Government will continue to allow for the arm’s-length test, it will seek to strengthen it to prevent it being used to justify higher quantum of debt or higher interest deduction when compared to the fixed ratio rule. The Government is also grappling with whether the worldwide gearing test should be repealed, where the adoption of the earnings-based fixed ratio rule is accompanied by a similar group ratio rule.

2. Great tax risk reporting to shareholders

The new rules would require disclosure to shareholders of “material tax risk” to assist shareholders, including disclosing tax haven exposure and “high-risk” tax positions.

There are existing disclosure obligations in ATO guidance such as PCG 2017/14 on related party debt funding, though this proposed disclosure regime would go far behind that standard. There are several questions this poses which we hope will be explored in industry submissions and future versions of the Paper, including:

• Would listed taxpayers be required to disclose tax risks even where they have reasonably arguable positions?
• How do you disclose enough to inform shareholders but preserve privilege and confidential information?
• How far beyond PCG 2017/4 would the disclosure obligation go?
• What new class action risks does this pose where shareholders complain that they were not adequately informed about a company’s tax position that is later the subject of ATO enforcement action?

3. Federal Government tenderers to disclose country of tax domicile

The Government announced that MNEs tendering for Australian Government contracts valued at more than $200,000 AUD (inclusive of GST) will be required to state their country of domicile for tax purposes. This will not apply to contacts offered by States and Territories. Whether the entity’s tax residency status should be used as the definition of tax domicile is subject to the consultation process.

Businesses that bid for Australian Government work that are potentially domiciled offshore should be asking:

• Whether they are likely to be domiciled offshore for the purposes of this disclosure?
• How the Government is likely to use this disclosure in assessing our bids (if at all)?
• Do representations made for these purposes have a bearing on the business’ tax profile vis-à-vis the ATO and other tax authorities.

Other reforms

Aside from the reforms explored above, the Government is also considering:

• limiting MNEs’ ability to claim tax deductions for payments relating to intangibles and royalties that according to the Government, lead to insufficient tax being paid. While ostensibly this would be intended to target royalties paid to traditional “tax havens”, the implications of this potential measure are far reaching and could potentially extend to royalties paid to a US tax resident, amongst other arrangements.
• the EU and the Global Reporting Initiative’s different approaches to public reporting to improve tax transparency and is seeking to determine the scope of tax information that should be required to be publicly reported by MNEs.