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International Taxation Issues to Consider – Part 3

Posted by Northadvisory on January 30, 2018

Most tax advisers will agree that one of the many ‘knock-on’ effects associated with the fast pace of globalisation is that businesses of all types and sizes are increasingly able to operate cross-border. It follows that a working knowledge of international tax principles can be very useful in day-to-day practice.

  1. The following considerations regarding Permanent Establishments are:
    • The permanent establishment rules under domestic tax law
    • The permanent establishment rules under the relevant Double Tax Agreement (DTA), which generally override domestic legislation
    • It is best to consider domestic rules first to determine whether a tax liability exists, then consider the application of the DTA to determine whether this alters the position
    • Can be done through a branch (the foreign entity having a direct presence in Australia), or through a subsidiary entity owned directly or indirectly by the foreign entity with ownership structure / inter-entity appropriation considerations.
  2. When deciding on a structure, tax consequences include:
    • Calculation of worldwide effective tax rate associated with streaming profits from Australia, and overall tax cost of distributing an amount of taxed profit back to the holding company
    • Consider direct taxes, withholding taxes, operation of DTAs and domestic tax rules of countries through which profits are streamed
    • Includes any number of entities/countries in a chain and can compare with other options for repatriating profits
    • Proof of any differences in overall tax cost to include commercial decision on which option to use
  3. Commercial considerations other than tax outcomes include:
    • Whether a shopfront or fixed place of business is required
    • A locally registered statutory entity may be more effective to obtain finance or tenders
    • Whether the presence will be for a short-term one-off project or for permanent operations
    • Whether costs of set-up and ongoing maintenance of the structure are acceptable
    • It can have the appropriate flexibility e.g. an exit strategy in the future
  4. Funding operations can be done through debt, equity or a combination of both. The considerations are:
    • Funding arrangements considered as a debt interest will be allowed deductions for interest payments, subject to thin capitalisation rules
    • Funding arrangements considered as an equity interest will allow franking of distributions
    • The commercial decisions include the level of risk associated with the financing
    • Thinly capitalised entities use a high level of debt and a small amount of equity, which will result in much higher interest deductions than if equity was used
    • Thin capitalisation rules don’t apply if:
      • You are an Australian resident entity that is not an inward investing entity nor an outward investing entity, or
      • You are a foreign entity that has no investments or permanent establishment in Australia, or
      • Your debt deductions (and associates) are $2 million or less
      • You are an outward investing entity that is not also foreign controlled and you meet the assets threshold test
      • You are a special purpose entity established to manage certain risks
  5. Appropriation of Profits back overseas includes:
    • Whether there is a withholding tax that applies to the distribution e.g. interest (10%), dividends (30% if unfranked, 0% if franked), or royalties (30%).
    • A payment may be deemed as paid even if not actually paid e.g. re-invested, accumulated, capitalised or dealt with on behalf of them
    • Management Fees are not subject to withholding taxes but must comply with transfer pricing rules / arm’s length considerations & documentation of actual services given
    • If income is classified as Conduit Foreign Income (CFI), then it may be exempt from withholding taxes and non-assessable non-exempt income for the non-resident as that income is actually from foreign sources even if earned through Australia
    • Three conditions for CFI are:
      • Must be ordinary or statutory income received by the company
      • Would not be assessable income of the company were treated as a foreign resident (income with non-Australian source)
      • The income is included in an income statement or similar statement (AASB)
  6. When selling inbound investments, there may be exemptions from CGT:
    • Foreign residents subject to CGT on capital gains arise only in relation to direct or indirect interest in Taxable Australian Property (TAP)
    • If an investment is through shares in an Australian company, it may be exempt if the shares are not TAP
    • TAP includes:
      • Real property located in Australia
      • Indirect interest in real property
      • Asset used to carry on a business through a PE in Australia
      • An option or right to acquire any of the above
      • An asset in resect of which a choice was made to disregard a gain or loss on ceasing to be an Australian resident
  7. Some inbound investments need to be approved by the Foreign Investment Review Board (FIRB). Notifiable actions include:
    • An acquisition of a direct interest in an agribusiness over relevant monetary threshold
    • An acquisition of a substantial interest in an Australian entity over relevant monetary threshold
    • An acquisition of an interest in Australian land over a relevant monetary threshold
    • Action prescribed by the Regulations, including a foreign government investor:
      • Acquiring a direct interest in an Australian entity or business
      • Starting an Australian business
      • Acquiring a legal or equitable interest in a mining, production or exploration tenement or an interest of at least 10% in securities in a mining, production or exploration entity
    • Notification requirements apply to all Australian land, including agricultural land, commercial land, residential land or a mining or production tenement unless an exemption applies.
  8. Regarding foreign investment into Australia, the ATO is responsible for:
    • Approving foreign investment in residential real estate and for register of foreign investment in agricultural land
    • Compliance activity to ensure foreign investors in residential property meet obligations under Foreign Acquisition & Takeover Act 1975 (FATA)
    • Agricultural Land Register from 01 July 2015 and for collection of fees for all foreign investment applications from 01 December 2015
    • Administration of all aspects of FATA for residential real estate and will maintain register related to foreign ownership from 01 July 2016.
  9. International Transfer Pricing Rules:
    • Refers to the process of setting prices charged between related parties for supply & acquisition of goods/services between those parties
    • Applies where an entity would otherwise get tax advantage in Australia from cross-border conditions and are inconsistent with the internationally accepted arm’s length principle
    • Australia has domestic tax legislation that allows the ATO to adjust prices charged between related enterprises
    • Basis for setting prices between related enterprises operating in more than one country is the arm’s length principle which requires prices charged to reflect prices that would have been charged if the enterprises had been independent and were dealing with each other at arm’s length
    • Documentation is required which records transactions in real time, and includes the transactional documents and further documentation that records why a pricing methodology has been adopted
  10. International Transfer Pricing – Simplified Documentation:
    • Eligibility criteria include materiality (international related party dealings are less than 2.5% of total turnover), small business taxpayers, distributors, intra-group services, management and administration services, technical services and low level inbound loans
    • These businesses can opt out to minimise record-keeping and compliance costs, in which case the ATO will not review records, but check whether the criteria have been met
    • The ATO and OECD position is that taxpayers should not be expected to prepare or obtain documentation beyond the minimum needed and enable reasonable assessment to be made on dealings with international related parties

If you have questions on any of the above issues raised, please do not hesitate to contact us.

Kim Edwards
Accountant
T: 02 9984 7774
E: kime@northadvisory.com.au