Australia: Corporate Taxation for Resident Multinationals

The tax regime for multinational companies in Australia is not very inviting, although the international business tax regime has been the subject of various reviews in recent years.

However, if a multinational corporation (meaning, a company with subsidiaries or affiliates in more than just one or two countries) needs to be based in Australia, it can take advantage of certain characteristics of the Australian tax system.

Resident companies pay tax on their worldwide income and capital gains (with certain categories of income and capital gains being exempted and with tax credits being granted where income and capital gains have already been taxed in a foreign jurisdiction).

A company is resident in Australia for tax purposes if:

• It is incorporated in Australia (irrespective of where central management and control is exercised). Once a company has been incorporated in Australia it can never lose its Australian residence for tax purposes.
  
• Central management and control is exercised in Australia (irrespective of which country the company was incorporated in).
  
• The company is neither incorporated in Australia nor is its central management and control exercised there but carries on business in Australia and its voting control is in the hands of resident Australian shareholders.

Double taxation of foreign income for resident Australian companies has traditionally avoided by the following rules (but see changes put forward by the Ralph Report and the relaxation of the CFC rules that took place in 2003):

• Income from subsidiaries resident in "listed" jurisdictions is exempt from any further tax in Australia, subject however to Controlled Foreign Corporation (CFC) rules. A listed jurisdiction is a jurisdiction which has a similar tax system to Australia. Since the income is exempt from further tax in Australia no tax credits can be claimed in the jurisdiction even if the tax paid abroad is higher than what would have been paid in Australia. For this rule to apply to a subsidiary the resident parent corporation must control at least 10% of the share capital.
  
• Income from subsidiaries resident in "unlisted" jurisdictions is taxed a second time in Australia but a tax credit is given for any tax already paid in the foreign jurisdiction whether it be corporate income tax, capital gains tax or withholding taxes. An "unlisted" jurisdiction is a jurisdiction which does not have a similar tax system to Australia (e.g. low tax offshore jurisdictions). For this rule to apply to a subsidiary the resident parent corporation must control at least 10% of its share capital.
  
• Where income with a foreign source has already been taxed in a foreign country and is to be taxed again in Australia a tax credit is granted to the resident corporation for any taxes paid in the foreign jurisdiction. Tax credits are granted under both the provisions of double taxation treaties and where there is no double taxation treaty in place under the provisions of domestic legislation. They cover corporate income tax, capital gains taxes and withholding taxes.
  
• If the corporate income tax payable in Australia is less than the tax which has already been paid in a foreign jurisdiction the balance of the tax credit can be carried forward for 5 years or transferred to other companies within a group.

Withholding taxes are imposed on outgoing dividends, royalties and loan interest payments. "Treaty shopping" whereby a corporation from a jurisdiction with which Australia has a particularly favorable double tax treaty is interposed between the Australian company and the foreign investor is an absolute necessity for a foreign investor seeking to reduce Australian withholding taxes on dividends (from 30% to 15%) and on royalties (from 30% to 10%). It is not possible to reduce the withholding taxes on interest payments through treaty shopping. Unlike some other countries there are currently no Australian laws against treaty shopping.

3 rates of withholding taxes are payable on dividends remitted from a resident subsidiary corporation to a non-resident parent corporation namely:

• 30% if the dividend is "unfranked" (ie it is being paid out of untaxed income) and the parent corporation is resident in a jurisdiction with which Australia does not have a double taxation treaty. This rate was reduced in stages to 7.5% by 2010 for certain distributions from Managed Investment Trusts for countries with which Australia has exchange of information agreements;
  
• 15% if the dividend is "unfranked" and the parent corporation is resident in a jurisdiction with which Australia does have a double taxation treaty
  
• 0% if the dividend is "franked" irrespective of whether or not the parent corporation is or is not resident in a jurisdiction with which Australia has a double taxation treaty.

Withholding tax is also zero on dividends paid out of income received from a 'listed' jurisdiction (see above).

Withholding tax stands at 10% on the interest on loans irrespective of the residence of the recipients, but it does not apply to the returns on federal bonds. The 10% rate will be reduced to 7.5% in 2014 and to 5% in 2015.

On outgoing royalties the withholding tax rate stands at 30% unless the recipient is resident in a jurisdiction with which Australia has a double taxation treaty in which case the withholding tax rate may be reduced to as low as 10%.

The Foreign Dividend Account Exemption: Dividends received by an Australian company from a foreign company may be put into a special segregated account known as the "foreign dividend account" and any dividend paid out of this "Foreign Dividend Account" to a non resident is exempt from withholding tax. The purpose of this provision is to take away an impediment under which multinational companies were deterred from transferring income through Australia. The Australian company must hold at least 10% of the foreign company's shares, and there are some further technical conditions.

Thin Capitalisation Rules: New legislation which came into effect in 2001 introduced 'thin capitalisation' rules for Australian business, ie putting limits on the amount of interest that can be deducted for tax purposes if a firm finances itself predominantly by loan capital, something that was a common practice for foreign companies wanting to extract returns from their Australian subsidiaries without incurring withholding tax on dividends.

In August 2007, then Minister for Revenue and Assistant Treasurer, Peter Dutton, introduced Tax Laws Amendment (2007 Measures No. 5) Bill 2007 to implement a number of improvements to Australia’s taxation system.

With regard to thin capitalisation, the legislation aimed to ensure that an integrity measure in the thin capitalisation rules operated as intended by removing from the definition of ‘excluded equity interest’ those equity interests that remain on issue for a total period of 180 days or more.

In addition, the legislation also sought to reduce compliance costs for groups containing ADIs (authorised deposit taking institutions), where the only ADIs in the group are specialist credit card institutions, by allowing the head companies of such groups to apply the rules as if the group did not contain any ADIs.

2002 Review Of International Tax Regime Responding to a barrage of pre-election criticism, the newly re-elected right-wing Australian government began an extensive review of business taxation in 2002.

The Government had been shocked when James Hardie Industries, a major building materials group, announced in July, 2001 that it would shift its base to the Netherlands in order to minimise tax charges. The widely diversified group has substantial international income flows.

"Higher rates of foreign tax are imposed on our foreign income when it is repatriated to Australia to pay dividends to shareholders. Under the current structure, this problem will increase as international demand for our products grows," said Peter Macdonald, chief executive.

The group said that adopting the new structure - which will also involve a secondary listing on the New York Stock Exchange - would nearly halve its average tax rate to about 30%.

Australian Assistant Treasurer at the time, Senator Helen Coonan announced in May 2002 that the Federal government planned to provide tax relief for companies looking to demerge, as long as they fitted certain criteria. In order to claim capital gains tax relief during the demerger process, the underlying ownership of the company must not change, but the demerging entity must divest at least 80% of its ownership interests in a subsidiary.

The proposals became effective in October, and Andrew Binns, Tax Partner with Ernst & Young Australia praised them, saying that: 'As companies get to understand it more, they will come to see it as allowing them to restructure in a way that makes them more valuable to shareholders.'

Mr Binns also argued that the move towards tax-free demergers is likely to provide a boost to the country's investment climate:

'The government is trying to encourage people to invest and take long-term views in the market,' he explained.'To have a tax cost, just because a company restructures to make it more efficient, is an impediment to that sort of activity.'

Restructuring companies will no longer suffer capital gains tax penalties, while shareholders will also benefit through the deferral of capital gains tax and relief of tax on deemed dividends.

"Business has reacted positively to the Government's demerger legislation and several large Australian companies have been keenly awaiting the passage of this Bill," said Senator Coonan, continuing: "Tax relief for demergers will increase efficiency by allowing greater flexibility in restructuring businesses, providing an overall benefit to the economy."

Pleased as it may have been by some signs of progress, Australian business interests were far from happy, and in October of that year, the Business Council of Australia (BCA) and Corporate Tax Association (CTA) suggested several reforms for the Howard government of the time to consider during its review of Australia's international tax regime.

BCA Chief Executive, Katie Lahey explained that: 'Simply put, our international tax systems are inadequate for a modern economy. The review provides a very timely opportunity to remove obstacles, reduce complexity and enhance the competitiveness of Australia's international tax law.

Among other topics, the submission addressed issues such as dividend imputation, controlled foreign company rules, tax treaties, conduit income, residency, foreign investment fund rules, and expatriate taxation.

CTA Executive Director, Frank Drenth announced that the submission sought especially to address the bias against Australian companies which invest offshore:

'That bias manifests itself through the way our system double taxes taxed foreign earnings when they are distributed to Australian shareholders - mums, dads, super funds - as unfranked dividends,' he told reporters, adding that foreign source income rules also need addressing, as they are currently too broad.

'At the moment, it's a bit like fishing with dynamite - you get a lot of fish, but you get a lot of other things that you don't necessarily want,' the CTA chief observed.

The government took further steps towards improving the international taxation regime for businesses in December, 2003, introducing measures which took effect from July, 2004, relaxing Controlled Foreign Company (CFC) rules as they apply to countries possessing broadly similar taxation regimes (BELCs), such as the US, the UK, Germany, France, Canada, Japan and New Zealand, in effect exempting income derived from outside such countries but passing through them (and therefore taxed in them).

"Once the package is complete", said Ernst and Young at the time, "Australian multinationals doing business in these major commercial centres will no longer need to be overly concerned with measures that are aimed at tax haven operations. The Government has clearly recognised the fact that business takes place in these countries for commercial rather than tax related reasons."

However, CFC rules will continue to apply to income derived through a trust or arising under the Foreign Investment Fund (FIF) measures, even if derived through CFCs resident in such comparable tax countries."

The new legislation also allowed fund managers to invest up to 10% of their fund in foreign passive investments before FIF rules apply, and will also relieve complying superannuation funds from the FIF measures. The amendments also provided a withholding tax exemption on widely distributed debentures issued to non-residents if those debentures are issued by public unit trusts.

Legislation introduced to the Australian parliament in April, 2004, simplified the taxation system for companies with offshore earnings by ensuring that they only pay a single layer of tax, according to the government.

Commenting on the New International Tax Arrangements (Participation Exemption and Other Measures) Bill 2004, the then Parliamentary Secretary to the Treasurer, Ross Cameron, noted: "The measures in this bill will directly assist Australian companies with foreign subsidiaries or branch operations by generally ensuring that they only pay one layer of (foreign) tax on the profits of those offshore operations as well as reducing compliance costs in many cases."

However, he added that “any passive or highly mobile income shifted to those offshore investments will continue to be taxed in Australia on an accrual basis."

The government hoped that the changes in the tax law would make Australian firms more competitive overseas, and Mr Cameron explained that they were designed to help small, as well as large firms.

"The changes are not just relevant to big business with extensive offshore operations," he observed. “They will also assist those emerging Australian businesses looking to expand offshore to take advantage of global opportunities."

Additionally, the new law allowed firms to ignore capital gains from the sale of shares in a foreign subsidiary, and would also expand the application of foreign dividend exemption to all nations.

In September 2004 the then Australian Treasurer Peter Costello indicated that he wanted to overhaul the country’s international taxation system to ease the tax burden on firms operating overseas.

Costello revealed that one of his top priorities was to help firms that derive much of their income overseas and pay tax on it but do not benefit from a domestic tax credit.

"I would like to improve Australia's international taxation arrangements so that Australian companies can expand in foreign jurisdictions, while remaining domiciled in Australia," Costello said. "We want to promote Australia as a place for regional headquarters - for Australian companies but also for foreign companies," he added.

Costello spoke as News Corp, the largest firm listed on the Australian Stock Exchange, prepared to move its domicile and primary listing to the United States.

In February 2006, a new study was launched, examining Australia's international competitiveness in the area of tax.

In 2008, the political guard changed, meaning that a number of the reform proposals put forward by the previous government were subjected to close scrutiny by its Labor successor.

In May 2008, Kevin Rudd's government formally announced that it was reviewing a raft of tax legislation proposed under the former coalition government of John Howard.

At the time the Parliament was dissolved on 15th October, 2007, prior to the federal elections, the previous government was still to enact almost 60 announced tax measures, and the Rudd government revealed that it had been working its way through this stock of announced but unenacted measures with a view to arriving at a decision on each of them and eliminating the considerable uncertainty that existed around them.

The Rudd government announced in May that it had already acted to introduce legislation to implement a number of them, including urgent measures such as that proposing tax-free treatment for superannuation lump sums paid to persons suffering from a terminal medical condition.

Measures which the government had decided should proceed, but where it proposed to make changes to the announcements by the previous government, were detailed in the Budget. The government also announced at that time those measures that it had decided should not proceed.

Measures which the government intended to proceed with included modifications to the income tax consolidation regime, and amendments to the thin capitalisation regime, to accommodate certain impacts arising from the 2005 adoption of Australian equivalents to International Financial Reporting Standards. It would also finalise the implementation of the simplified imputation system and proceed with new tax treaties with Japan and South Africa, the Rudd administration announced.

The government had not, however, decided whether to press ahead with a programme of Tax and Information Exchange Agreements (TIEAs) with offshore jurisdictions, it emerged. Nor had it at that time made a final decision on foreign dividend tax proposals, a review of tax secrecy, disclosure and anti-avoidance provisions, amendments to company residency rules, and modifications to transfer pricing provisions.

In August 2008, the Australia’s Future Tax System (AFTS) Discussion Paper was launched by Treasury Secretary Dr Ken Henry - claimed to be the most comprehensive review of the country's tax system in fifty years.

The wide ranging review encompassed many aspects of the federal and state/territorial tax system, and considered: the balance of taxes on work, investment and consumption and the role for environmental taxes; enhancements to the tax and transfer system facing individuals, families and retirees; the taxation of savings, assets and investments, including the role and structure of company taxation; the taxation of consumption and property and other state taxes; simplification of the tax system, including the interactions between federal, state and local government taxes; and the proposed emission trading system.

The review did not, however, consider the rate and base of the GST, and interactions with the transfer system.

"Long-term reform of our tax and welfare systems is a key way to secure our economic foundations for the future, create wealth, spread opportunity and reward working Australians," announced a statement issued by Treasurer Wayne Swan.

Legislation to modernize the CFC regime was due to come into effect in 2010 but delays in implementation led to a postponement with a further draft amendment to the CFC regulations published in February, 2011. It is widely expected that the new rules will apply from July, 2012.

Double Taxation Treaties

Australia has double tax treaties with virtually all of its major trading partners (around 50 countries at the time of writing). The majority of these follow the OECD model treaty, and in all of Australia's full treaties, there is usually a 'tie-breaker' clause to deal with those who might otherwise be treated as residents of both Australia and the treaty country.

In November, 2005, New Zealand and Australia signed a protocol updating the 1995 double tax agreement between the two countries.

“Our double tax agreement with Australia is our most important tax treaty, given the significance of our economic relationship and trans-Tasman investment, so it is essential that it is kept up to date,” New Zealand's Revenue Minister Peter Dunne stated on Tuesday.

Mr Dunne went on to explain that: "Whether we negotiate a completely new double tax agreement between the two countries is still under review. It will depend in part on whether New Zealand is willing to lower the withholding rates covered by the agreement, a decision the government expects to make next year."

"In the meantime, the protocol signed today makes urgent administrative changes to the agreement to ensure it works to maximum benefit for both parties."

“The protocol updates the article in the agreement governing exchange of information and inserts a new article to allow assistance with tax collection. These changes will assist the extension of Australia’s Wine Equalisation Tax Rebate to New Zealand wine producers who export to Australia."

“It also ensures that Australia does not lose priority over New Zealand’s 28 other treaty partners to negotiate lower treaty withholding rates should we decide to reduce them."

“The amended agreement will be given effect in both countries once they have introduced the necessary domestic legislation, which in New Zealand’s case will be an Order in Council, probably early next year."

In September 2008, the Australian parliament approved a new tax treaty with Japan.

Initially, the new Rudd government was undecided whether to press ahead with a programme of Tax and Information Exchange Agreements (TIEAs) with offshore jurisdictions. But by the end of August 2009, it had signed TIEAs with seven jurisdictions, including Bermuda, Antigua and Barbuda, the Netherlands Antilles, the British Virgin Islands, Jersey, Gibraltar and the Isle of Man. A tax information exchange agreement has also been added to the double tax agreement with Singapore.

Following in the footsteps of the Rudd government, the new administration has continued to sign and ratify TIEAs with Anguilla, Aruba, Bahamas, Belize, Cayman Islands, Cook Islands, Dominican Republic, Monaco, San Marino, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Turks & Caicos Islands and Vanuatu. Agreements with Andorra, Bahrain, Costa Rica, Grenada, Liberia, Liechtenstein, Macao, Marshall Islands, Mauritius, Montserrat and Samoa have yet to come into force.