This article provides a summary of the proposed new measures aimed at denying deductions for payments made by SGEs who seek to exploit intangible assets and low tax jurisdictions.
On 31 March 2023, Treasury released Exposure Draft legislation (Draft Bill) that introduces a new anti-avoidance provision aimed at denying deductions for payments made by Significant Global Entities (SGEs) in relation to intangible assets connected with low tax jurisdictions. This is consistent with The Federal Government’s broader strategy to address key concerns regarding the taxation of multinational groups.
The explanatory material to the Exposure Draft indicates the measure is designed to deter SGEs structuring their business such that income from the exploitation of intangible assets is derived by an associate in a jurisdiction that provides a tax outcome of nil tax or low tax rate of less than 15 per cent or the country provides for a preferential patent box regime without sufficient economic substance underlying the relevant tax concession.
The deterrent is achieved by denying SGEs tax deductions for payments attributable to intangible assets to an associate or, in circumstances where an SGE mischaracterises payments, for example a service fee, even if a no amount is invoiced for exploitation of intangible asset, a deduction could be denied to the extent it is considered attributable to exploitation of intangible asset.
Once legislated, the proposed amendments will apply to payments made on or after 1 July 2023.
The legislation is currently in exposure draft on which BDO has made a submission to Treasury.
Proposed provision to deny deductions
Proposed section 26-110(2) denies a tax deduction for a taxpayer that has made a payment to an associate to the extent it is attributable to a right to ‘exploit’ or otherwise has the ability to exploit an intangible asset. The following conditions are required for the denial to apply:
- The taxpayer is an SGE for the income year
- As a result of the arrangement under which the taxpayer makes the payment, or a related arrangement, the taxpayer or an associate of the taxpayer:
- acquires the intangible asset or
- acquires a right to exploit the intangible asset or
- exploits the intangible asset
- Entering into the arrangement by the SGE taxpayer results in the recipient entity or another associate deriving income in a low corporate tax jurisdiction directly or indirectly from exploiting the intangible asset or a related intangible asset.
Definition of key terms
As a result of
The use of the expression ‘as a result of’ means that it is not necessary that the payment and the acquisition of the right to exploit, or the exploitation of, an intangible asset are provided for in the same contract.
The definition of ‘payment’ under the proposed measure includes liabilities incurred or amounts credited in relation to the intangible assets.
Where income is derived indirectly by an interposed entity, strict tracing through the flow of funds for the use of the intangible assets is not required and it is sufficient that a payment exists between each entity (e.g. for services provided). It does not matter whether a payment is made to the recipient directly or indirectly through one or more entities. This can include, for example, direct payments to an entity that holds an intangible asset in a low tax jurisdiction, or payments made indirectly to that entity through other entities in the global group.
The proposed new provision would apply ‘to the extent’ the payment is ‘attributable to a right to exploit an intangible asset’. However, the explanatory material indicates that strict tracing is not required and where the Australian entity has access to use an intangible asset owned by an associate without being required to pay for that access, the existence of payments between entities that are associates for another purpose (for example, for services provided), is enough to deny a part of the deduction for that payment.
There are several issues of concern in the Exposure Draft legislation including:
Scope of provision
The proposed measure is quite broad in its application to payments that relate to the exploitation or the acquisition of rights to exploit intangible assets. Unfortunately, the explanatory material is lacking in enough examples and further guidance regarding its application.
Wide definition of low or nil taxed jurisdiction
The definition of ‘low or no tax jurisdiction’, as it currently stands, would include any high tax jurisdictions that provide tax exemptions for particular income classes whether or not they are associated to income from intangible assets.
Tracing of indirect payments
The lack of a requirement to directly trace indirect payments will result in SGEs having to look at all payments to other group members to consider whether there is a connection with any payments that the other group member makes to an associate in a nil or low tax jurisdiction that may be attributable to the use or exploitation of an intangible asset. This will be a very difficult and costly process for the SGE.
No Guidance on apportionment
Regarding mischaracterised payments that will result in the partial non-deductibility of the payment, there is no guidance on how to apportion the non-deductible portion of the payment.
The explanatory material makes reference to a specific shortfall penalty which is being considered. We do not consider a specific shortfall penalty is necessary for this measure as the deduction denial is a sufficient penalty.
Any SGEs who consider the rules may apply to them should review their current arrangements relating to payments made to associates for intangibles connected with low corporate tax jurisdictions.
Contact a local BDO tax adviser to assist with this review, or to answer any questions regarding the content of this article.