Australia

Ian Farmer
PwC
Australia

Tax policy makers have been active in Australia but there is still progress to be made concerning a coherent strategy, believes Ian Farmer of PwC

From an economic perspective, Australian business is recovering from the global financial crisis. As businesses seek to stabilise financially in a recovering economy, the impacts of inefficiencies in the tax system on Australia's competitiveness and business agility are magnified – and while there have been some small steps made around Australian tax reform agenda, there is still some way to go.

The broader tax reform agenda was not pursued in the Budget in May 2011 and will probably take many years to unfold. Business and other sectors of the community remain hopeful that the 2011 Tax Forum announced by the government of Prime Minister Julia Gillard for October 2011, will revitalise the debate and provide it with fresh impetus.

Minerals Resources Rent Tax

The most notable tax reform measure after the Henry Review findings in May 2010 is the Mineral Resource Rent Tax (MRRT). Originally proposed by the government as the Resource Super Profit Tax (RSPT), the government backed down from its RSPT proposal after significant industry pressure. In its place, it developed the proposals for the MRRT (with input from a select group of large resource houses in Australia) in conjunction with an extension to the existing Petroleum Resource Rent Tax (PRRT) regime.

The MRRT will apply to iron ore and coal projects in Australia, while the PRRT will be extended to apply to all onshore and offshore oil and gas projects, including the North West Shelf. The MRRT is proposed to apply to both new and existing projects from July 1 2012, however there are measures which will reduce the MRRT payable of projects in existence as at May 2 2010 by providing a deductible 'starting base' reflecting prior investment.

In June 2011, the much anticipated Exposure Draft (ED) legislation for the MRRT was released and was accompanied by detailed explanatory material. While the release of the ED was a major milestone of the consultation process and a significant step towards the implementation of the proposed MRRT, this ED is still not a finalised document with several, important and/or contentious topics yet to be drafted. The final ED is envisaged to be released later this year.

Notably, the draft legislation for the extension of the petroleum resource rent tax (PRRT) to all Australian oil and gas projects was not released simultaneously. This legislation is expected in the near future.

Private equity investment into Australia

In December 2010, the Australian Taxation Office (ATO) issued two final tax determinations (TDs) and two new draft TDs, after highly publicised actions taken by them against a foreign private equity (PE) investor in the wake of the 2009 listing of Myer, an Australian department store business.

On November 11 2009, the Australian commissioner of taxation sought to prevent the distribution of proceeds from an initial public offering of Myer Holdings Limited to its non-resident PE investor, based on an assertion that Australian tax was payable on the profits. Through the release of these determinations, the ATO sought to clarify its views concerning the liability to Australian income tax on gains made by foreign PE investors in Australia (based on a specific set of circumstances).

In the two final TDs, the commissioner finalised his views, indicating that:

Australia's anti-avoidance rules can apply in cases of treaty shopping, and
foreign private equity investors can make an income gain from the disposal of assets.

In the two draft TDs, the commissioner has set out his preliminary views, indicating that:

the source of profits from certain sales of Australian shares should be determined by reference to a substance over form approach
the source is more likely to be Australian and therefore, in the absence of treaty relief, the gains will be taxable in Australia, and
certain non-resident investors may still benefit under tax treaties even where they invest via a limited partnership in a tax haven (for example, a Cayman LLP).

It is has been clear that these TDs are relevant to particular facts (that is, an investment made by a Cayman fund, through interposed holding companies in Luxembourg and the Netherlands), and do not address recent developments, such as investing through an Australian managed investment trust.

While further clarity still needs to be provided by the ATO and Treasury on various issues, some of the principles contained in these determinations provide a useful insight into the ATO's thinking in relation to the taxation of gains arising out of private equity investment into Australia.

Controlled foreign company regime

On February 17 2011, the Australian Federal Government released the long awaited draft legislation to modernise the controlled foreign company (CFC) regime and the proposed foreign accumulation fund (FAF) rules.

The CFC and FAF rules, in broad terms, seek to tax Australian residents on certain passive income derived through foreign investment vehicles on an accruals basis. The amendments are proposed with the aim of making Australia a more attractive location for regional headquarters companies and include these highlights:

all sales and services income should be exempt from attribution
passive income derived through a permanent establishment (PE) and which arises from the CFC competing in a market, through the ongoing use of labour within the CFC's country of residence should be exempt from attribution
rental income from overseas real estate should no longer be subject to attribution
royalties are likely to remain generally subject to attribution
exemptions for listed countries and AFI subsidiaries have been retained
transactions between active members of a CFC group should generally not give rise to attribution, and
complying superannuation entities and life insurance companies should be exempt.

However, as expected, the draft legislation proposes to restrict the availability of the foreign dividend participation exemption to equity interests only.

While the operative framework of the draft CFC legislation remains broadly unchanged from the consultation papers released in 2010 and uncertainty still remains about the start date for both the CFC and FAF rules, all-in-all the exposure draft represents a step in the right direction.

Reportable tax position schedule

On May 11 2011 the ATO released a draft Reportable Tax Position (RTP) Schedule for comment. The schedule will require some large business taxpayers to disclose information about their reportable tax positions as an attachment to their annual income tax return. The ATO's strategy is reflective of the global trend towards greater corporate transparency, for example, the US Internal Revenue Service (IRS) introduced a somewhat similar schedule in 2010.

Broadly, a reportable tax position is:

a material position that is not more likely to be correct than incorrect
a position in respect of which uncertainty about taxes payable or recoverable is recognised and/or disclosed in a taxpayer's or related party's financial statements, or
a position in respect of a reportable transaction (as defined).

A taxpayer will be required, for each RTP, to provide a brief description of the facts that underlie the position the taxpayer has taken, including listing relevant case law, legislative references and/or ATO views relied on to support their position.

The schedule supports the ATO's broader strategy to improve transparency and governance on tax matters for Australian corporate taxpayers and accelerate identification and resolution of technical issues. Initially only taxpayers in Quadrant 1 (higher risk) and Quadrant 2 (key taxpayers) under the ATO's large market Risk Differentiation Framework who are notified in writing by the ATO, will be required to complete the RTP schedule. Taxpayers with an annual compliance arrangement will not be required to complete the schedule.

The ATO issued a final release of the schedule by the end of June 2011 with application to income years commencing on or after July 1 2011, though it is expected that the related guidance and commentary will continue to be clarified past this date as consultation continues.

International dealings schedule

The International Dealings Schedule for Financial Services (IDS-FS) became mandatory for certain taxpayers for the 2011 income year. The IDS-FS forms part of the income tax return and requires financial services taxpayers to disclose information about their cross-border transactions. Taxpayers impacted are:

financial services entities (excluding super funds) with gross turnover of A$250 million ($270 million) or more on their previous year's income tax return
general and life insurance entities, and
foreign banks and foreign bank branches.

The IDS-FS represents a significant increase in the information a financial services taxpayer is required to disclose to the ATO. This includes information about:

financing activities, insurance and reinsurance activities with international related parties
documentation and pricing methodologies for international related-party dealings, including for royalties, share-based remuneration, derivatives, debt factoring, securitisation arrangements, service arrangements, and loans
restructures involving international related parties
offshore banking units
interests in foreign entities, and
thin capitalisation.

The IDS-FS is a move by the ATO towards a more strategic risk assessment process where it can assess more of the risk upfront and thereby allocate resources more effectively in relation to key compliance areas such as transfer pricing, cross-border arbitrage and tax haven activity.

Taxation of financial arrangements

For many medium and large taxpayers, the year ended June 30 2011 is the first year of application of the new Taxation of Financial Arrangements (TOFA) rules, which are intended to minimise the extent to which the tax treatment of financial arrangements distorts trading, investment and financial decisions, and risk taking and management. This is achieved under the new provisions by allowing, at the taxpayer's option, greater alignment between the tax and accounting recognition of gains and losses from financial arrangements.

The TOFA provisions apply to most medium and large corporate taxpayers, being broadly, those with more than A$100 million turnover (when aggregated with certain affiliated and connected entities), or more than A$100 million in financial assets or A$300 million in gross assets. As mentioned, one of the key features of the regime is the ability to make choices in relation to how the provisions apply. For example, taxpayers can choose to apply the provisions to new financial arrangements only, or to bring all pre-existing financial arrangements into the regime. Taxpayers can also, subject to certain eligibility criteria, choose to apply one or more of four elective tax timing methods, which will help to achieve greater alignment between tax and accounting results. The elective methods include a method to recognise gains and losses on a fair value basis, a method to allow foreign-exchange gains and losses to be recognised on a retranslation basis and a method to allow gains and losses on hedging instruments to be matched (in both timing and character) with the gains and losses on the hedged item.

Tax consolidation regime

In June 2010, the Australian Federal Government made a number of changes to the tax consolidation regime that is available to corporate groups. These changes were significant as they explicitly allowed a tax deduction for costs allocated to certain "rights to future income", and in many cases, the change could be applied retrospectively to July 1 2002 (giving taxpayers the opportunity to amend prior year tax returns, and in many cases, claim additional tax deductions, without the usual two or four year time limits).

The amendments allow for a tax deduction for the reset tax cost amount allocated to a "right (including a contingent right) to receive an amount for the doing of a thing", which is available where a new entity joins a tax consolidated group and brings rights not created external to the group. Examples of rights which may be eligible for the deduction include long-term construction contracts, trailing commissions under insurance agent contracts, land development rights and management agreements.

While these amendments were legislated more than a year ago, there has been much debate this year as the ATO, tax advisers and companies seek to establish the boundaries for this new deduction. As a result of this uncertainty, and likely concerns about the potential cost to the revenue, in March 2011 the federal government asked the Board of Taxation (which acts in an advisory capacity to government) to review the rules and clarify their scope. The possibility of law change, even a retrospective law change, cannot be ruled out. The board has now reported, confidentially, to government and we are awaiting the government's announcement on how it intends to proceed.

Ian Farmer (ian.farmer@au.pwc.com), Sydney