Government cracks down on tax avoidance through foreign investment rules

The Turnbull Government announced yet another measure aimed at addressing tax base erosion and profit shifting, placing additional requirements on new foreign investment under the existing national interest test.

In the last 12 months Australia has seen various reforms within the tax system. However, this latest initiative is a shift as it links Australia’s tax regime with its foreign investment regime. It sends a broader signal to the market that Australia will look beyond the collection of tax revenues to a consideration of national interest.

Foreign investment proposals are reviewed against national interest on a case-by-case basis. The possibility of applying penalties for both failure to comply with Australia’s foreign investment framework and for non-compliance with domestic law has always been there. However, the Treasurer Scott Morrison stated that the new rules will provide:

“greater compliance powers for the Australian Taxation Office and strict new penalties for those caught breaking the rules”.

The general presumption is that foreign investment is beneficial. Morrison then has the power to determine whether a particular investment is contrary to national interest. However, the term “national interest” is not defined anywhere, the Treasurer is able to determine what factors should be considered in deciding this.

The impact of a foreign investment proposal on Australian tax revenues was already listed as one of the factors considered when determining national interest. The extent to which an investor operates on a transparent commercial basis and is subject to adequate and transparent regulation has also always been included as part of the factors when applying the test. However, no tax specific obligations were imposed on applicants. Additional requirements will change this.

New rules on tax avoidance

Under the new conditions emphasis will now be squarely placed on compliance and disclosure. The Australian Taxation Office (ATO) will have strengthened powers, including ordering international companies to divest Australian assets if they are found to be non-compliant.

The true test, however, will be the requirement that an applicant notify the ATO of any dealings or transactions to which Australia’s transfer pricing rules or anti-avoidance rules may apply. The applicant will also be required to provide an annual compliance report to the Foreign Investment Review Board.

As such, the onus will move towards the international investor to demonstrate that they are meeting their tax obligations. Where a significant risk is identified, an applicant may have additional conditions applied. These include engaging with the ATO in good faith to resolve any tax issues and providing additional information such as a minimum forecast of tax payable.

International tax reform

This latest initiative arguably sits well within current international tax reform and builds on the already significant changes to tax compliance and disclosure which have occurred in Australia. The most notable change introduced in 2015 was the Tax Laws Amendment (Combating Tax Avoidance) Act 2015 which passed both houses of government in 2015.

That Act achieved three important outcomes. First, it extended Australia’s anti-avoidance regime, commonly referred to as Part IVA, to introduce what is known as the multinational anti-avoidance law. Second, stronger penalties to combat tax avoidance and profit shifting were introduced. This doubled the penalties imposed on significant global entities that enter into tax avoidance schemes. Third, a reporting mechanism known as country-by-country reporting was introduced. The last initiative is part of Australia’s commitment to the G20 and Organisation for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) program.

In December 2015, Australia also saw the release by the ATO of the first Corporate Transparency Report. Designed as part of the package of initiatives to improve corporate transparency, it revealed that 38 percent of entities did not pay tax in 2014. Both Australian and foreign entities make up the 1,539 corporations included in the transparency population. However, of significance is the fact that 985 corporations, or 64 percent, are foreign-owned entities.

Australia has also been active on the international stage, signaling to other jurisdictions its commitment to addressing international tax avoidance. On 27 January 2016, Australia along with 31 countries, signed the Multilateral Competent Authority Agreement for the automatic exchange of country-by-country reports. The Common Reporting Standard, a single global standard for the collection, reporting and exchange of financial account information on foreign tax residents, is also to commence on 1 July 2017.

When viewed as a suite of reforms, this latest initiate is positive. However, there is still significant work to be done to curb profit shifting by multinational entities. Subsequent to the release of the G20/OECD final BEPS package, Australia needs to decide whether to implement various recommendations.

Treasury is gathering different views on adopting the new OECD transfer pricing guidance in the context of the Australian tax system. This is just one example of potential future developments. As such, reform is ongoing with each initiative a valuable part of the overall solution to tackling international tax avoidance. The current measure linking the tax regime with the foreign investment regime is no exception.