AUSTRALIA: CORPORATE TAXATION FOR RESIDENT MULTINATIONALS

See below for changes introduced in 2003 and 2004

The tax regime for multinational companies in Australia is not very inviting, although in 2002 the government began an extensive review of the country's international business tax regime, which is widely acknowledge to be sub-optimal.

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 is avoided by the following rules (but see changes put forward by the Ralph Report):

• 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 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;
  
• 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. Double taxation treaties have no effect on the rate of withholding tax.

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% as in the case of the tax treaty signed with the Netherlands Antilles.

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.

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, Senator Helen Coonan announced in May 2002that 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 Helen Coonan, Minister for Revenue and the Assistant Treasurer. "Tax relief for demergers will increase efficiency by allowing greater flexibility in restructuring businesses, providing an overall benefit to the economy."

Mayne, CSR, Coles Myer and Orica were some of the companies which were expected to proceed with restructuring plans to take advantage of the new legislation.

Pleased as it may have been by some signs of progress, Australian business interests were far from happy, and in October the Business Council of Australia (BCA) and Corporate Tax Association (CTA) suggested several reforms for the Howard government 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.

Less positive news for international businesses came in December, 2002, when the NSW Supreme Court ruled against US-based Unisys Corporation, which had claimed that it was not obliged to pay withholding tax on royalties received through a licensing partnership with Unisys Australia, arguing that any royalty payments from the Unisys licensing partnership (ULP) arose as a result of the ULP's US business activities.

'The Court was told that Unisys Corporation sub-leased rooms to the partnership in the US and the only functions carried out in these rooms were the filing and retrieval of the partnership's records (approximately 100-200 pages of information),' the ATO statement explained. Justice Gzell supported the ATO's challenge, explaining that although the rooms leased to the partnership in the US were at the disposal of the ULP, they could not be said to be the place 'at or through which' the partnership carried on its business.

'The storage and retrieval of documents could hardly constitute the carrying on of Unisys licensing partnership's business,' he ruled, ordering the corporation to pay both the royalty withholding tax for which it is liable in Australia and the ATO's costs.

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, "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 allows 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 proposed amendments also provide 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, 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 is hoping that the changes in the tax law will make Australian firms more competitive overseas, and Mr Cameron explained that they are 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 would allow 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 Australian Treasurer Peter Costello indicated that he wants 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 is 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.

Double Taxation Treaties

Australia has double tax treaties with virtually all of its major trading partners. At the time of writing, these include: Argentina, Austria, Belgium, Canada, China, the Czech Republic, Denmark, Fiji, Finland, France, Germany, Hungary, India, Indonesia, Ireland, Italy, Japan, Kirabati, Korea, Malaysia, Malta, Mexico, the Netherlands, New Zealand, Norway, Papua New Guinea, Philippines, Poland, Romania, Singapore, Spain, Sweden, Switzerland, Sri Lanka, Taipei, Thailand, the United Kingdom, the United States and Vietnam. 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."