Board of Taxation review of tax arrangements applying to permanent establishments
Banking on Tax, Issue 9
In May 2012, the Government commissioned the Board of Taxation to examine and report on the advantages and disadvantages of Australia adopting the OECD functionally separate entity approach to determining the profits attributable to a permanent establishment (PE) in its tax treaty negotiations and in domestic law.
The Board’s review has involved an extensive public consultation process, including the release last October of a discussion paper inviting comment on a substantial number of questions and issues. For the financial services sector, the key issues raised include:
- The practical differences between the approach under current Australian law and the authorised OECD approach (AOA), and hence the implications of Australia’s adoption of the AOA
- The appropriateness of retaining Part IIIB of the Income Tax Assessment Act 1936 for foreign bank branches in Australia, and in particular the LIBOR cap limiting interest deductions under that provision
- Whether the AOA achieves appropriate tax outcomes for Australian insurance businesses, and the appropriateness of retaining Division 15 of the Income Tax Assessment Act 1936.
In summary, Deloitte’s submission to the review made the following comments on these issues:
- Current Australian law (e.g. Subdivision 815-A of the Income Tax Assessment Act 1997 and the 2008 OECD Commentary on the existing Article 7) incorporates a ‘limited AOA’. There is little to no difference between the limited and full AOA for the financial services sector, as the limited AOA recognises the concept of economic ownership of financial assets and internal dealings, such as interest and risk transfers, for the purposes of attributing profit according to the arm’s length principle and having regard to economic substance
- The LIBOR cap in Part IIIB should be removed. It causes significant issues as it is often significantly lower than the actual cost of funds. The arm’s length principle (in conjunction with the existing thin capitalisation provisions) provides a better framework to determine deductible debt in Australia
- For insurance, the proper application of the principles set out in the AOA should lead to an appropriate arm’s length allocation of profits to PEs involved in the operation of an Australian insurance business. It is timely that discussions occur on whether it continues to make sense to maintain Division 15 of the Income Tax Assessment Act 1936.
Deloitte’s submission expressed its view that the Board of Taxation should provide a strong recommendation that Australia adopt the AOA in Australia’s treaties and domestic law.
In the meantime, as part of its current process of reforming Australia’s transfer pricing rules, the Government has recently introduced a bill into Parliament whose purpose is to ‘modernise’ (i.e. replace) Division 13 of the Income Tax Assessment Act 1936, including in respect of PE profit attribution. The proposed new law includes provisions (in Subdivision 815-C) whose stated intention is to codify the ‘relevant business activity approach’, so that “…Subdivision 815-C reflects the approach to the attribution of profits to permanent establishments that is currently incorporated into Australia’s tax treaties”. This is on the basis that the Government is yet to decide on whether to adopt the AOA (functionally separate entity approach) in Australia’s tax treaties.
The Board of Taxation’s report is due to Government by the end of April. We remain hopeful that it will recommend adoption of the AOA in Australia’s treaties and domestic law. For multinational corporations (MNCs) straddling many borders, including Australian-owned MNCs, the AOA is the only internationally recognised and harmonious guidance on these matters. It is vital to have a common set of rules to allow businesses to run efficiently, promote investment into Australia and reduce the risk of double taxation.