Australian Treasury releases updated Exposure Bill and Explanatory Materials for Intangibles Integrity Measure

• Updated Exposure Draft legislation has been proposed to amend Australia's tax rules to limit deductions for certain payments related to intangible assets that significant global entities make, directly or indirectly, to associates in a low corporate tax jurisdiction.
  
  
• The Updated Exposure Draft contains a number of key changes from the previous version circulated.
  
  
• The measure is still proposed to apply to payments or credits made or liabilities incurred from 1 July 2023.

Executive summary

Following consultation on Exposure Draft legislation and submissions by EY and others, on Friday, 23 June 2023, the Australian Government released an updated Exposure Draft bill (ED) and exposure draft Explanatory Materials (EM) for the Intangibles Integrity Measure (Treasury Laws Amendment (Measures for Future Bills) Bill 2023: Deductions for payments relating to intangible assets connected with low corporate tax jurisdictions).

The measure is still proposed to apply to payments or credits made or liabilities incurred on or after 1 July 2023; however, Parliament does not sit again until 31 July. This means the measure will apply despite there being no final law and no prospect of the law's being introduced into Parliament before 31 July.

Intangibles integrity measure

Similar to the previous Exposure Draft bill released in March 2023 (seeEY Global Tax Alert, Australian Treasury releases Exposure Draft Bill to deny deductions for payments by significant global entities to low-tax jurisdictions relating to intangible assets, dated 4 April 2023), this ED introduces an anti-avoidance rule designed to deter significant global entities (SGEs) with global revenue of at least AU$1 billion from avoiding income tax by structuring their arrangements so that income earned from exploiting intangible assets is derived in low corporate tax jurisdictions while deductions for payments to associates attributable to the intangible assets are claimed in Australia. Where the rule applies, the Australian payer is denied a deduction for such payments.

The key changes from the previous ED include:

1. Definition of low corporate tax jurisdiction

The ED clarifies that the relevant rate of corporate income tax is the national headline corporate income tax rate, being the income tax rate applicable to income derived in the ordinary course of carrying on a business. Deductions, offsets, tax credits, tax losses, tax treaties, concessions for intra-group dividends, exemptions for particular industries, exemptions for particular types of income, and rates that apply only to foreign residents are disregarded. This clarifies the position for many jurisdictions that provide certain exemptions and concessions but have a corporate rate of 15% or more.

Based on the definition, both Ireland and Switzerland remain low corporate tax jurisdictions.

2. Disregarding taxed income

The ED includes concessions aimed at identifying income derived in a low corporate tax jurisdiction that may nonetheless be subject to a tax rate of at least 15%. Where this income can be identified, it will be treated as derived other than in a low corporate tax jurisdiction for purposes of the measure and thus a deduction will not be denied. This income includes:

1. Income classified as attributable income under the Australian controlled foreign company (CFC) regime
2. Income "subject to foreign income tax" of at least 15%

"Subject to foreign income tax" is as defined in section 832-130 of the Income Tax Assessment Act 1997, with certain modifications. Modifications include disregarding the application of a foreign country's foreign hybrid mismatch rules and taking into account state and municipal taxes. As a result of this definition, income that is included in the tax base of another country under CFC rules that are similar to Australia's rules will also be considered. Considering state and municipal taxes may mean that certain income derived in Switzerland (for example) would not be subject to a denial.

Unlike the definition of low corporate tax jurisdiction (which applies to the specific country), this concession will require taxpayers to identify the income that is subject to a particular tax rate or treatment in a foreign country.

3. Royalty withholding tax

Where a deduction would otherwise be disallowed and the taxpayer has remitted withholding tax, the amount of the deduction denied will be proportionately reduced by the amount of withholding tax remitted. In that regard, where the full non-treaty withholding rate of 30% applies, no deduction will be denied.

4. New SGE penalty

The new ED contains a new SGE penalty, which applies if a deduction is denied under the proposed measure. This penalty applies in addition to the existing penalties in the Taxation Administration Act 1953. As a result, a shortfall that arises due to the proposed measure will attract the existing shortfall penalties and the new proposed penalty, resulting in a quadrupled penalty for shortfalls.

5. Global minimum taxes/domestic minimum taxes

The ED does not address the impact of any proposed Pillar Two Qualifying Domestic Minimum Top-Up Taxes (QDMTT) implementation. Note that Attachment 2 of the Explanatory Memorandum to the Treasury Laws Amendment (Making Multinationals Pay Their Fair Share — Integrity and Transparency) Bill 2023 (introduced into Parliament on 22 June 2023), at page 96, states that "The interactions between the intangibles legislation and Pillar Two global and domestic minimum taxes will be considered during Australia's implementation of its global and domestic minimum taxes."

Treasury also noted in the Statement of Outcomes from the consultation process that the Government is further considering interactions of the intangibles measure with global minimum taxes and domestic minimum taxes. It appears that where the relevant income is subject to Pillar Two style domestic minimum taxes in a particular country this is not considered as being "subject to foreign taxes."

This means that jurisdictions like Ireland remain in-scope at this time.

6. Substantive requirements

There are some changes to the wording of the proposed law and some additional commentary and examples in the EM that will need further review. This includes an additional example on related arrangements and examples related to the definition of low corporate tax jurisdiction.

Importantly, some minor word changes in the EM relate to genuine distribution arrangements and the distribution of tangible assets and the tangible asset exemption. Based on these changes, Taxpayers will need to do further work to ensure their arrangements involve payments for goods rather than payments for intangible assets, such as trademarks.

Action required

Given the imminent start date of the proposed rules, affected businesses should finalize their analysis of the impact of the new rules and consider approaches to payments made after 1 July 2023.

For additional information with respect to this Alert, please contact the following:

Ernst & Young (Australia), Sydney

• Sean Monahan, International Tax and Transaction Services
• Tony Cooper, International Tax and Transaction Services
• Leonid Shaflender, International Tax and Transaction Services
• David Tracey, Transfer Pricing
• Sandra Farhat, Tax Controversy
• Alf Capito, Tax Policy

Ernst & Young (Australia), Brisbane

• Reid Zulpo, International Tax and Transaction Services

Ernst & Young (Australia), Perth

• Joe Lawson, Transfer Pricing

Ernst & Young (Australia), Melbourne

• Michael Jenkins, Transfer Pricing
• Tony Merlo, Tax Policy

Ernst & Young LLP (United States), Australia Tax Desk, New York

• Naomi Ross

Ernst & Young LLP (United Kingdom), Australia Tax Desk, London

• James Poulos

Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.