On 31 March 2023, the Australian Treasury issued the exposure draft (ED) on denying deductions of payments made for the use of intangible assets to associated entities located in low tax jurisdictions. The object of this proposed legislation is to deter Significant Global Entities (SGE) from avoiding tax by structuring their arrangements relating to the use of intangible assets.
The proposed changes are pursuant to the announcements made in the 2022‑23 Federal Budget and the consultation on Multinational Tax Integrity and Tax Transparency. The ED is open for comments from stakeholders until 28 April 2023. The proposed date of effect is for payments made on or after 1 July 2023, so your urgent attention is required if you may be impacted.
If the changes are enacted as proposed, an amount will not be deductible for payments made on or after 1 July 2023 if:
- you are an SGE;
- you pay to an associate entity, either directly or indirectly;
- payment is attributable to the acquisition, use, or exploitation of an intangible asset; and
- the associate entity derives income in a low corporate tax jurisdiction.
- Importantly, deductibility is proposed to be denied even in cases where tax has been withheld on royalty payments.
1. Payment attributable to intangible assets
The proposed law seeks to capture a broad range of payments attributable to intangible arrangements, including arrangements that result in the acquisition of an intangible asset, or a right to exploit an intangible asset, or a permission to exploit an intangible asset.
The ED also requires consideration of an arrangement, including collateral contracts and legally unenforceable understandings between the parties, and includes arrangements where the payment is made directly or indirectly to an associate entity.
As an anti-avoidance provision, the proposed law also seeks to circumvent mischaracterisation of payments.
A broad definition of exploitation of intangible assets is proposed to capture a variety of ways in which intangible assets can be exploited by an SGE group, including:
the use of, marketing, selling and distributing the intangible asset;
the supply, receipt or forbearance of an intangible asset as per the ‘royalty2‘ definition;
exploiting another asset that is a right or an interest in an intangible asset; and
doing anything else in respect of the intangible asset.
2. Intangible asset
The ED adopts a broad definition of “intangible assets” to include “things” as per the definition of royalty in subsection 6(1) (except paragraph (b)) of Income Tax Assessment Act 1936 and extends to a wide range of intangible assets.
The amendments include a regulation-making power to provide for the ability to prescribe new assets to which the section applies, thus allowing the Government to make timely changes to the regime.
The ED lists some examples of activities that would be considered to be within the meaning of exploiting an intangible asset, including:
- the copying of an item of copyright or software;
- the issuance of a licence key or other piece of information that allows access to a piece of software or a database;
- accessing information contained on a database;
- the deploying of or accessing the output of an algorithm;
- a right to distribute products on behalf of an associate in return for consideration that involves marketing, selling or distributing the intangible asset even when that intangible asset, such as a software licence, is distributed directly from the offshore associate to the customer.
3. Low tax jurisdiction
Deductibility is to be denied only if an associate of the SGE derives income in a low corporate tax jurisdiction from exploiting an intangible asset. A low corporate tax jurisdiction is one where the lowest national level corporate income tax rate under the laws of that foreign country, applicable to an SGE, is less than 15%. Where no income tax applies on a particular amount of income, the rate is treated as being nil.
For foreign countries with progressive corporate income tax rates, only the highest rate will be relevant in determining whether that country is a low corporate tax rate jurisdiction.
Where different income tax rates apply depending on the type of income derived, only the lowest tax rate is relevant for this purpose. This proposal is significant as the lowest tax rate may be applicable, regardless of whether it applies to the income from the intangible arrangement.
4. Tax preferential patent box regime
The ED also proposes to deny deductions for payments to associates where income from exploiting the intangible asset is derived in a jurisdiction determined by the Minister as providing for a preferential patent box regime without sufficient economic substance in that jurisdiction. This is intended to ensure that the legislation has the power to quickly adapt and capture any harmful patent-box regimes.
5. Applicable to SGEs
The proposed law applies to SGEs, which broadly includes entities forming part of groups, or “notional” groups, with consolidated global income of over AUD 1 billion. Given the broad definition of SGEs, the proposed ED may affect taxpayers regardless of their income or presence in Australia.
With 1 July 2023 just around the corner, we recommend that taxpayers revisit their related party arrangements to identify potential exposure now given the broad scope of the proposed legislation.
Our tax consulting team can assist you in determining the implications of these proposed changes. Get in touch with us today and a member of the team will contact you shortly.
The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex Group Limited.