Corporate tax developments to watch in 2023

Development in the treatment of intangible assets

In 2021, the ATO released draft Practical Compliance Guideline PCG 2021/D4. This draft concerns the ATO’s compliance approach to international arrangements that are connected with the development, enhancement, maintenance, protection and exploitation of intangible assets. It also focuses on tax risks associated with the:

• potential application of the transfer pricing provisions;
• withholding provisions;
• capital gains tax;
• capital allowances;
• general anti-avoidance rule; and
• diverted profits tax.

The draft PCG has now been through its consultation process and the ATO expects to release the completed version in early 2023.

Draft PCG 2021/D4 aims to help taxpayers identify arrangements that the ATO considers to be high risk by setting out the Commissioner’s compliance approach and risk assessment framework. The draft guidelines make it clear that the level of documentation is a critical part of the ATO’s assessment of tax risk for such arrangements.

Multinational groups should ensure that ownership and utilisation of intangibles, as well as the commerciality behind every relevant transaction, are recorded carefully.

Taxpayers should also keep a watch on Draft Taxation Ruling TR 2021/D4. This was issued on 25 June 2021 and is intended to replace Taxation Ruling TR 93/12. The draft ruling deals with the circumstances in which receipts from the licensing and distribution of software will be royalties. TR 2021/D4 is expected to be finalised in mid-2023.

BEPS Pillars 1 & 2

Over 135 countries agreed to the OECD’s two-pillar solution in 2021 to combat base erosion and profit shifting. While these measures were originally slated to come into force in 2023, the timeline has since been revised. Though negotiations are ongoing, the OECD announced on 11 July 2022 that the multilateral convention to implement Pillar One was on track for delivery by mid-2023 for entry into force in 2024. The OECD will also develop model rules for implementing the multilateral convention into domestic law as part of this revised plan.

Pillar One is designed to reallocate taxing rights over large multinationals, from resident jurisdictions to market jurisdictions. For multinationals with revenue of more than €20 billion, taxing rights over 25% of their profits that exceed 10% of their revenue will be reallocated proportionately among market jurisdictions. Notably for Australia, extractive industries are exempt from Pillar One.

The two-pillar solution complements the Australian Government’s multinational tax avoidance package. A public consultation process was undertaken in 2022 and findings are expected to be released in 2023.

Off-market share buy-backs and franking credits

On 25 October 2022, the Federal Government handed down the 2022-23 Federal Budget announcing proposed changes to the tax law to align the tax outcomes for listed public companies (LPC) undertaking on-market and off-market share buy-backs.

Currently, where an LPC undertakes an on-market share buy-back, the shareholder will generally recognise a capital gains tax event and be taxable to the extent the capital proceeds exceed their tax cost base (where the shares are held on capital account). Alternatively, where an off-market share buy-back occurs, there is a bifurcation of the proceeds such that part of the buy-back price is assessable as a capital gain and the other part is assessable as a dividend which may be frankable.

The Federal Government is concerned that the difference in tax outcomes between an on-market and off-market share buy-back may incentivise LPCs with significant franking credits to undertake off-market share buy-backs at a lower buy-back price while compensating the shareholder with franking credits. This could be attractive for certain types of shareholder entities (e.g. superannuation funds) which have tax rates lower than 30% that would receive additional franking credits that may be used to offset other income. 

On 17 November 2022, Treasury released an exposure draft of the Treasury Laws Amendment (Off-Market Share Buy-Backs) Bill 2022 (ED) for consultation with stakeholders. The ED seeks to address the integrity concerns by:

• removing the ability of the LPC to treat part of the purchase price of an off-market share buy-back as a dividend whilst still requiring the LPC to debit its franking account as if it had paid a franked dividend; and
• treating the consideration paid by an LPC for a selective capital reduction as unfrankable whilst still requiring the LPC to debit its franking account.

It is intended these measures, once enacted, will apply to off-market share buy-backs and selective capital reductions undertaken by an LPC that are announced to the market or which occur after 7:30 pm AEDT on 25 October 2022.

Offshore multinational companies remain on notice

Announced in the Federal Labour Government’s first budget in October 2022, multinational companies will be targeted in a series of proposed measures to tackle inappropriate offshore debt gearing levels and deductions related to royalty payments to offshore related entities.

The most significant of the proposed changes concern Australia’s thin capitalisation rules and involve the replacement of the existing safe harbour and worldwide gearing tests with an earnings-based test, which will limit deductions to 30% of an entity’s profits, and a new earnings-based group ratio test. This measure affects all entities currently subject to Australia’s thin capitalisation rules. It is proposed that arm’s-length test will also no longer be available for related party debt and will be restricted to an entity’s third-party debt. Any deduction denied under the 30% profits test could potentially be carried forward for up to 15 years, subject to the normal tests that apply to prior year tax losses.

The other measures are aimed at ‘significant global entities’, which are members of a global group with gross revenue of at least $1 billion. The first is a new anti-avoidance provision which will prevent deductions made directly or indirectly to related parties in relation to intangibles held in low-tax or no-tax jurisdictions. The second measure will require entities to prepare certain information for public release by the ATO.

These measures should be kept in mind together with the ATO’s finalisation of its transfer pricing guidance in Draft PCG 2021/D4 and Draft TR 2021/D4 expected for release in 2023.

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