Appendix 3
A
consistent and useful effective tax rate methodology to assess the global tax
performance of multinationals in relation to Australian-linked business
operations[1]
The purpose of this paper is to propose a metric for the
global tax performance of multinationals in relation to their Australian-linked
business operations.
The formula is intended to identify an economic group’s
total worldwide profit from Australian linked business activities, and the
Australian and offshore tax paid on that profit. This will provide an
indication of total tax borne as well as the proportion of those profits
actually taxed in Australia.
Our development of this formula is continuing, but it is
considered that the formula is at a stage of development that means it can
provide useful information on effective tax borne on a “like for like” basis.
Note that we have not yet had the opportunity to consult
with taxpayers or other stakeholders during the development of this
methodology. In the ordinary course of events this is something we would
certainly seek to do, however, given the time constraints, this has not been
possible to date.
It should also be recognised that views differ as to the
appropriate formula to use to calculate effective tax rates and that the
response to this methodology is likely to be no different. There is merit,
particularly in the context of the debate on multinational tax, in having a
standardised approach to effective tax borne to facilitate like for like
comparisons (both domestically and internationally). This formula is an option
for how that standardised approach might look and is intended to encourage
broader discussion about the need for, and appropriateness of, a standardised
approach to calculating effective tax borne.
The metric
Denominator
The denominator is the total economic group profit from
business activities which are linked to Australia. There is a variant which
excludes some abnormal items from the profit calculation.
The starting point is the consolidated accounting profit of
the Australian group (which may include offshore subsidiaries). To develop the
estimate of the total economic group profit from business activities linked to
Australia, it is necessary to make a range of adjustments to that profit
(especially for inbound multinationals, where the Australian accounts will only
be a subset of the economic group’s activity).
Numerator
There are two alternative numerators under the combined
metric:
-
the Australian tax (including non-resident withholding taxes)
paid on those business activities by the economic group;
-
the global tax paid on those business activities by the economic
group.
General comments
This metric deliberately includes profits of the economic
group which may not be taxable in Australia under Australia’s source, residency
and anti-profit shifting rules or the OECD/Double Tax Agreement principles
intended to avoid double taxation. The metric seeks to reflect all of the
channel profit derived from business activities involving Australia and the
Australian and global tax paid on that channel profit.
Alternative methodologies, which are simply based on
consolidated Australian accounting profit without adjustment (especially for
inbound multinationals), beg the question around appropriate pricing of
international related party dealings and whether they are at arm’s length. By
including the entire economic group’s profit from Australian linked activities,
international related party dealings are effectively ignored.
Under the metric, where some of an economic group’s activities
are undertaken in low tax jurisdictions, the average global tax rate may
legitimately be below (or significantly below) the Australian corporate tax
rate. By including a metric which incorporates global tax, it will demonstrate
a weighted average global tax rate on those business activities. In reporting
this metric, a taxpayer may wish to provide an explanation of the proportion of
profits taxable in relevant jurisdictions.
The amount of Australian tax paid will reflect the impacts
of tax policy settings (ie the legislative rules that define the Australian tax
base, any tax expenditures taken into account in the tax reconciliation process
and tax credits and offsets that may be available) as well as the impacts of
any base erosion and profit shifting activities.
The methodology seeks to align the Australian accounting
consolidated group with the Australian tax consolidated groupings and
aggregation of Australian tax payments may be needed in some cases where there
is more than one tax consolidated group in the economic group.
The analysis is designed to apply equally to Australian
headquartered entities that are purely domestic (domestic entities), Australian
headquartered entities that also have offshore investments (outbound MNEs), and
foreign headquartered entities that have investments in Australia and may also
be using Australia as a regional headquarters (inbound MNEs).
The elements raised in this paper are indicative and are
unlikely to be exhaustive. In applying the metric to a particular taxpayer:
-
The general principles of the paper should be applied as far as
possible where there are scenarios not contemplated in the paper;
-
If the methodology is considered to provide a misleading outcome
in the particular circumstances, this should be disclosed;
-
Where it is not possible to obtain precise information in
relation to particular adjustments, a “best estimate” approach should be
adopted within materiality principles.
Comments in relation to profit of the economic group
The methodology starts with the accounting profit of the
Australian economic group. This will include offshore subsidiaries of the
Australian economic group, but will not include offshore parent entities or
sister entities.
A series of adjustments are required to be made to:
-
Include economic group profit from business activities which have
an Australian element but are not included in the consolidated accounts of the
Australian accounting group (relevant primarily to inbound MNEs);
-
(Potentially) exclude economic group profit (and the related tax)
from operating businesses in offshore subsidiaries which have no Australian
connection (relevant primarily to outbound MNEs).
Where transactions with offshore entities are already within
the consolidated Australian accounting group, no adjustment is required as the
third party income and expenses are already reflected in the consolidated
Australian accounting group and the effects of related party dealings (both
onshore and cross-border) are washed out in the course of the accounting
consolidation process.
The specific adjustments are discussed below.
Income earned from Australian
residents by offshore companies not within the Australian accounting
consolidated group
The economic group may earn income from Australian residents
outside the Australian accounting consolidated group.
This revenue should be included in determining the profit to
the economic group attributable to the Australian business operations.
Third party costs incurred in deriving that revenue should
similarly be included (which could include purchases from third party
suppliers, depreciation on plant and equipment etc).
Purchases and other services from
offshore related parties
Where the Australian accounting group purchases goods and
services from offshore related parties, the offshore entity will usually make a
profit (offshore) as part of that supply chain.
Under the metric, the entire supply chain profit is a profit
of the economic group arising from Australian business activities.
As such, the profit of other group companies from these
sales should be included in the metric.
This means that accounting profit should be adjusted to
exclude payments for goods, services and intellectual property from related
parties, but should then be adjusted to include third party expenses in manufacturing
/ purchasing the goods, providing the services and/or developing the
intellectual property. This could include depreciation / amortisation of plant
or capitalised intellectual property costs.
This would include profit made offshore on agency sales by
related selling agents.
Sales to offshore related parties
(including trading hubs)
Where the Australian accounting group sells goods or
services to offshore related parties, the offshore entity will usually make a
profit as part of that supply chain.
Where that profit is not already included in the Australian
accounting profit, the economic group profit should be adjusted accordingly.
This could be implemented by adding the profit of the
offshore entity or by excluding the sales revenue earned from the related
party, and replacing with the revenue from its on-sales to third parties, less
its other third party expenses (including employee costs).
Excessive debt allocations to
Australian entities
The Australian group will have third party debt attributable
to its operations (and the related interest expense in its financial accounts).
It may also have related party debt from its offshore parent
/ sister companies (occasionally but rarely from offshore subsidiaries).
For the purposes of this methodology, it is assumed that
interest on third party debt is a legitimate business expense of the Australian
operations (noting that in some cases that debt may actually be extended on the
security of offshore subsidiaries).
Related party debt may reflect:
-
A specific on-lending of third party debt raised offshore;
-
A general on-lending of third party debt (resulting in the
Australian operations having the same level of third party indebtedness as the
entire group); or
-
An incremental gearing level in Australia over the group’s level.
In relation to the first two categories, any margin earned
by the related party on the onlending is a profit to the economic group
attributable to the Australian business operations.
In relation to the third category, the incremental interest
income of the related party is a profit to the economic group attributable to
the Australian business operations.
Similar principles apply in relation to other financing
elements such as related party derivatives and foreign exchange gains and
losses.
Equity accounted subsidiaries
There are complexities relating to equity accounted
subsidiaries (ie subsidiaries where there is a significant holding, but not
enough to tax consolidate).
There are three proposed approaches:
-
to include the relevant percentage of their profits in the
economic group profit (and following on from this, the relevant percentage of
their tax); or
-
to exclude the profit attributable to equity accounted
subsidiaries, but to then include dividends from the subsidiaries in economic
group profit (potentially 'grossing up' for underlying tax borne at the
subsidiary level).
-
to exclude the profit attributable to equity accounted
subsidiaries entirely.
Any of these approaches should be acceptable.
Abnormal items
Accounting profit in a particular year may be artificially
suppressed (or inflated) through impairments or revaluations of intangible or
other long term asset holdings (such as property).
These amounts should be excluded to provide a normalised
accounting profit.
Other extraordinary items should also be excluded where
appropriate.
Comments in relation to tax paid
Use of tax paid rather than income
tax expense
The proposed metric is based on tax actually paid in
relation to a period rather than income tax expense according to accounting concepts.
In this regard, income tax expense for accounting purposes
may include amounts which are not likely to be paid / received in the short to
medium term (“deferred tax expense”). It may also include amounts such as “risk
provisions” for potential tax disputes. On the other side, it may be
artificially low through the generation of carry forward losses in part of a
group, which cannot be offset against gains from another part of the group.
Some taxpayers may wish to provide a reconciliation of total
income tax expense to tax paid (primarily the amounts which make up deferred
tax expense, although there may be some current tax expense items). Many of
these items will be impacts of deliberate tax policy settings (for example
accelerated depreciation).
This could include elements such as:
-
Tax losses recouped
-
Accelerated depreciation for tax purposes (including immediate
write-offs of items such as exploration expenditure)
-
Deferred tax liabilities for “top up” tax under offshore CFC
regimes
Exclusion of royalties and excise
It is not proposed to include royalties and excise in the
metric as these are not generally considered to be income taxes and apply to
some but not all industries.
However, it is important to note that these taxes do
contribute to the total contribution to Government of an economic group.
Withholding taxes
Where an amount of income is included in economic group
profit (eg through adjusting to include interest income received by offshore
companies from Australian entities), the relating Australian withholding tax
should be included in Australian tax paid.
Offshore tax
Where a profit or margin earned by an offshore entity is
included in economic group profit, that tax should be included in the global
tax paid.
This will include tax paid on those profits in third
countries under controlled foreign company rules and/or on repatriation of
those profits.
Equity accounted subsidiaries
Depending on the methodology adopted for equity accounted
subsidiaries, different approaches need to be taken in relation to underlying
tax.
-
Under the first methodology, the relevant proportion of
underlying tax paid should be included;
-
Under the second methodology, an amount should be included based
on the average underlying tax rate applicable to the equity accounted
subsidiary (effectively 'grossing up' the after tax profits distributed to a
pre-tax amount);
-
Under the third methodology, no amount should be included.
Disputed amounts of tax
Where there are significant disputes in relation to tax
payable (for example, taxpayer objections or litigation in relation to returns
lodged, or requests for amendment not yet processed), these should be
separately disclosed and an adjusted metric separately provided.
Where there is an amended assessment and there has been an
arrangement to pay half the tax in dispute, different approaches can be taken:
-
Include the arrangement amount with no further disclosure;
-
Include disclosures around best/worst case scenarios (i.e.
reflecting the positions where either party is successful in litigation); or
-
A probability approach based on litigation risk.
Methodology
Comprehensive normalised profit
Consolidated accounting profit of Australian entities /
branches (including offshore subsidiaries)
Adjustments for income earned from
Australian residents by offshore companies not within the accounting
consolidated group
- Add sales to Australian residents not included in
Australian group accounting profit
- Include third party costs incurred overseas in deriving
those sales (eg purchases from third party suppliers) not already included in
Australian accounts.
Adjustments for purchases and other
services from offshore related entities
- Exclude cost of goods sold on items purchased from related
companies (which are not in the Australian accounting group)
- Include third party costs in manufacturing / purchasing
those goods*
- Exclude cost of other property purchased from related
companies (which are not in the Australian accounting group), eg, debts sold in
a factoring business
- Include third party costs in manufacturing/acquiring that
property*
- Exclude expenses for services from related companies
(which are not in the Australian accounting group), including management and
administrative services
- Add profit made offshore on agency sales by related
selling agents (which are not in the Australian accounting consolidated group)
- Include worldwide third party costs of those services not
already included in Australian accounts*
- Exclude royalty expenses for intellectual property
obtained from related companies (which are not in the Australian accounting
consolidated group)
- Include third party expenses incurred in developing such
intellectual property not already included in Australian accounts*
Adjustments for sales to offshore related entities
- Add profit made offshore in trading hubs (which are not in
the Australian accounting consolidated group)
- Add profit made offshore in other subsidiaries from the
on-sale of goods and services acquired from Australian entities (net of amounts
already included in Australian accounting group by way of sales or other
revenue)
Adjustments for excessive debt
allocations to Australian entities
- Exclude interest expense on loans from related companies
(which are not in the Australian accounting consolidated group)
- Include interest expense on third party loans where those
loans are specifically on-lent to the Australian group
- If Australian group has third party borrowings (and
specifically on-loaned amounts) less than worldwide level, include estimated share
of worldwide third party interest expense required to bring Australian group to
average level of third party borrowing (average debt load at average rate)
- Exclude income and expenses for derivatives with related
companies (which are not in the Australian accounting consolidated group) (to
the extent the economic group has not entered into back to back derivatives
with third parties)
- Exclude foreign currency gains or losses on loans or
derivatives from related companies (which are not in the Australian accounting
consolidated group) (to the extent the economic group has not entered into back
to back transactions with third parties)
- Include any third party costs of foreign currency hedging
for Australian dollar exposure for Australian dollar funds provided to
Australian group if not already included in Australian accounts*
Adjustments for equity accounted
subsidiaries
Depending on methodology adopted:
- Adjust to include relevant percentage of profits
- Exclude all profits attributable to the equity accounted
subsidiaries; and/or
- Include dividends received from equity accounted
subsidiaries (potentially 'grossed up' for tax)
- Subtract profit attributable to equity accounted minority
holdings in subsidiaries
Comprehensive profit (A)
- Exclude revaluations / impairments on intangibles
- Exclude other extraordinary items where appropriate
Comprehensive normalised profit (B)
Effective tax paid
Australian corporate tax actually
paid in relation to the period
- Add: Australian interest withholding tax paid on related
company borrowings (to extent interest income included in adjusted group
profit)
- Add: Australian royalty withholding tax paid on related
company royalties (to extent royalty income included in adjusted group profit)
- Add: Australian dividend withholding tax paid on dividends
remitted (to extent dividend income included in adjusted group profit)
- Add: (assuming relevant approach taken to equity accounted
subsidiaries) proportionate share of Australian corporate tax actually paid by
non-100% subsidiaries where profit included in Australian consolidated
accounting group
- Add/Subtract: amended assessments / objections / requests
for refunds of tax not yet processed
Total effective Australian tax paid (C)
- Foreign tax paid on business operations included in
accounting group consolidated profit
- Foreign tax paid on related party interest income (to
extent included in adjusted group profit)
- Foreign tax paid on related party royalty income (to
extent included in adjusted group profit)
- Foreign tax paid on dividends received from Australian
group (to extent included in adjusted group profit)
- Foreign tax paid on profit on goods sold to Australian
group (to extent included in adjusted group profit)
- Foreign tax paid on related party services income (to
extent included in adjusted group profit)
Total effective foreign tax paid (D)
Total effective global tax paid (E)=(C + D)
Metrics to assess the global tax performance of multinationals in relation
to Australian linked business operations
Australian tax performance on
Australian linked business operations
Australian effective tax paid ratio: C/A
Australian normalised effective tax paid ratio: C/B
Global tax performance on
Australian linked business operations
Global effective tax paid ratio: E/A
Global normalised effective tax paid ratio: E/B
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