17 May 2013

'Tackling tax avoidance and profit shifting in the 21st century' - Opening Address to the Melbourne Law School

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University Of Melbourne

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Acknowledgements

Thanks very much, ladies and gentlemen, for your kind welcome, and good morning.

I'm really pleased to have been invited here today and I am honoured to open this conference on tax avoidance in the 21st century.  Although, I must confess that I'd be a lot more comfortable if the title of the conference was 'Cracking Down on Tax Avoidance in the 21st Century'!

It is a timely theme and it's one I've been quite vocal about recently.

But, before I begin, I'd like to extend my thanks to Mr Allan Myers [AO QC] for funding the Oxford/Melbourne Law School Research Partnership, which has supported this event.

I would like to acknowledge the members of the Judiciary:  Justice Edmonds (Federal Court of Australia), Justice Pagone (Supreme Court of Victoria), and Justice Glazebrook from the Supreme Court of New Zealand.

I would also like to acknowledge distinguished academics from Canada, Britain and New Zealand.  Thank you for coming from near and far to this important Conference.

And finally I would like to acknowledge members of the Expert Roundtable on Part IVA that I established last year to provide advice to the Government on the reforms to Part IVA; some of whom are here today.   

The final legislation was a better Bill because of your efforts.

Introductory remarks

What I would like to do today is set out the Government's view of how tax avoidance fits within the broader policy context.

But first, I will provide an overview of the amendments to Part IVA that are currently before Parliament, and how the Government sees the role of the General Anti‑Avoidance Rule as an integral part of the Australian taxation system.

Overview of Part IVA amendments before Parliament

This Government is committed to ensuring that Australia continues to have a strong and effective General Anti-Avoidance Rule.

As everyone here today will be aware, amendments to reform Part IVA – Australia's general income tax anti-avoidance provisions – are currently before Parliament.

These amendments passed the House of Representatives yesterday.

The amendments are designed to remedy a technical deficiency in how Part IVA identifies and measures the tax advantage secured by an arrangement entered into for the purpose of avoiding tax.

To use the language of Part IVA, how it identifies and measures the 'tax benefit'.

The amendments do not change the substantive operation of the dominant purpose test in Part IVA, which distinguishes between tax avoidance and legitimate tax planning.

Of course, taxpayers will not be affected by the amendments unless they participate in arrangements for the sole or dominant purpose of obtaining a tax advantage.

Changes to 'tax benefit'

So, what are the changes to the concept of 'tax benefit'?

Part IVA measures the tax benefit secured by an arrangement, and it does this by comparing the actual tax position achieved by that arrangement with the tax position associated with a comparator arrangement – usually referred to as the 'counterfactual'.

Recent court decisions confirmed that, for the purposes of Part IVA, the counterfactual was to be identified by a hypothetical inquiry into what else the taxpayer would have done had they not entered into the scheme.

As a result, the counterfactual did not have to be another way in which the substantive results of the scheme – if there were any – might otherwise have been achieved.

I should make clear that this is not a criticism of the Court's judgment.  It is the proper role of the Court to interpret the laws the Parliament makes.

However, as a consequence of that finding, taxpayers who entered into arrangements in a way that predominantly avoided tax could conceivably escape the operation of Part IVA simply by demonstrating that they wouldn't have entered into the arrangement had they known it would attract tax.

So, for example, they could argue that they wouldn't have done anything at all, or that they would have done something with a different substantive effect from the arrangement they had, in fact, entered into.

Indeed, this type of argument would have been particularly persuasive in the context of voluntary internal group re‑organisations, where it could readily be concluded that the re‑organisation would not have proceeded had it been known that it would attract tax of any magnitude.

In the Government's view, this is an inappropriate policy outcome because it makes it possible for taxpayers to avoid the tax consequences of what they have actually done.

To be truly effective, Part IVA should peel back the artificial and contrived elements of a transaction to expose its actual economic substance to the operation of the taxation laws.

This requires an inquiry into whether the transaction could have been achieved through other, more straightforward or conventional ways.

It does not require – nor is it assisted by – an unconstrained enquiry into what else the taxpayer might have done if they had their time over again.

To that end, the amendments before Parliament clarify that there are two alternative bases for postulating counterfactuals upon which the existence of a tax benefit can be demonstrated.

The first basis, which concerns tax advantages that would not have been obtained without the scheme, is an 'annihilation' approach.

This accommodates cases where simply removing the scheme would reveal a coherent taxable situation consistent with the substance of what happened.

The second basis, concerning tax advantages that might reasonably be expected not to have been obtained without the scheme, is a 'reconstruction' approach.

The reconstruction approach accommodates cases where what remains after removing the scheme would not make sense, or would be inconsistent with the taxpayer's actual commercial objective.

Instead, it requires one to theorise about other ways the substance of what happened might reasonably have been achieved.

The amendments make it clear that, in determining whether a counterfactual is a reasonable alternative to a scheme, regard should be had neither to the tax cost of the scheme nor to the tax consequences of the counterfactual.

That is because the tax differential between the scheme and the counterfactual is exactly what the 'tax benefit' concept is trying to measure.

I note that some have suggested that a counterfactual – one that is otherwise a functional substitute for the scheme – is not a reasonable substitute for the scheme because it would have produced a greater tax liability than the scheme itself.

To accept this would be to allow the tax benefit gained from the scheme to function as a shield against Part IVA.

Perversely, the greater the tax benefit, the more effective the shield.

Some stakeholders have argued that this approach will require taxpayers to may the 'maximum' amount of tax, using the least tax efficient way to achieve their objective.  Or, to put another way, that the legislation before the Parliament will interfere with legitimate tax planning.

However, let us remember that 'tax benefit' is only one element that must be satisfied for Part IVA to apply.

The central element – the element that distinguishes between tax avoidance and legitimate tax planning – is the purpose test.

The Government believes that the purpose test is working well and will continue to objectively differentiate between these motives.

As such, the Government considers that these amendments will ensure that Part IVA continues to operate as intended — that is, to counter arrangements carried out in an artificial or contrived way to avoid tax.

Maintaining an effective General Anti-Avoidance Rule is essential to protecting the integrity of our tax system. 

And the Government's amendments to Part IVA will do just that.

These changes will not only ensure that a key policy element of the tax system operates as intended, it will also protect revenue of over $1 billion a year.

General Anti-Avoidance Rules operate in a broader context

As you are aware, a General Anti-Avoidance Rule has long been one of the features of Australia's tax landscape, with Part IVA being part of the tax law since 1981.  Earlier provisions date back to at least 1915.

Of course, General Anti-Avoidance Rules do not exist in a vacuum.

The role a General Anti-Avoidance Rule plays depends on domestic and international business practices; the design and interpretation of the broader tax laws; the complexity of those laws; and also the tax 'culture'.

This broader environment is rarely static. 

Many of you here today will recall the 1970s 'bottom of the harbour' schemes.

You may also recall how the tax culture at that time influenced the replacement of the predecessor section 260 with our current General Anti-Avoidance Rule, Part IVA.

Through its role as an instrument of deterrence, Part IVA has, in turn, beneficially influenced tax culture.

It is clear that a General Anti-Avoidance Rule is more effective when other parts of the tax law it operates in are structurally strong. 

In Australia, Part IVA is not, and never should be, the first line of defence against tax avoidance.

And that requires a constant review of the effectiveness of existing provisions of the tax law.

As the world changes, our tax laws must change with it.

Tax avoidance has become a global issue

I have talked a number of times recently about this challenge.

How structural changes occurring in the global economy combined with aggressive tax planning by some multinational entities pose a threat to Australia's corporate tax base.

How, if left unchecked, profit shifting and international tax avoidance is a threat to Australia's sovereign right to tax.

How international tax rules have failed to keep pace with the fundamental changes in the way global business is carried out.

Structural changes in the global economy, such as the rise of the 'global supply chain', increased trade liberalisation, technological developments and the increasing importance of intangibles in the digital age, have put pressure on the international tax rules that were designed in the early 20th Century.

The Government firmly believes that steps must be taken – nationally and internationally – to ensure that our tax system remains relevant in the modern global economy.

As the OECD said in its recent report on Addressing Base Erosion and Profit Shifting, "what is at stake is the integrity of the corporate income tax."

Beyond the loss of revenue that's involved, base erosion and profit shifting fundamentally undermines the fairness and efficiency of our tax system.

When some taxpayers exploit loopholes to minimise tax, those who play by the rules are obviously penalised.

In that sort of world, commercial advantage is predicated on aggressive tax planning, rather than improving productivity, lowering costs and serving one's customers better.

Protecting Australia's corporate tax base

This Government is playing a strong role in international efforts to counter base erosion and profit shifting, and the issue is firmly on the G20's agenda.

In February this year the Treasurer wrote to his G20 Finance Minister counterparts calling for a global action plan to combat base erosion and profit shifting.  A number of G20 leaders have also highlighted the issue of tax reform addressing profit shifting and tax avoidance by multinational companies. 

Following the OECD's report on base erosion and profit shifting earlier this year, the OECD is now developing an action plan to help address these issues in a comprehensive manner.  The action plan is expected to be released in July this year in time for the G20 Finance Ministers meeting later in the year.  

As I said in a speech in March this year, Australia intends to take full advantage of our role in the G20 this year, and in 2014 when we host the G20 to pursue global solutions to these problems.

In Australia, the Government released an issues paper on multinational profit shifting earlier this month, developed by the Treasury in consultation with the Specialist Reference Group on multinational taxation issues.  The Specialist Reference Group comprises experts from the community sector, academics, business and the tax profession.  I encourage you all to participate in the consultation process. 

But, although multilateral initiatives have an important part to play here, individual countries must also ensure their domestic laws are appropriately applied.

That's why, in this year's Budget, the Government announced a package of measures aimed at protecting Australia's corporate tax base from erosion and loopholes.

Artificial debt loading

The Government will tighten the rules to stop multinational enterprises shifting profit out of Australia by artificially loading up their Australian operations with debt.

The ability of multinationals to use debt to shift profits offshore is recognised by all OECD countries as a threat to corporate tax bases.

As part of these reforms, we are tightening Australia's thin capitalisation rules from 3 to 1 debt to equity to 1.5 to 1. 

This better reflects normal commercial levels of gearing.  According to Treasury analysis of the 2011 financial statements for over 2000 ASX listed companies (other than banks), 95 per cent of those companies had gearing levels less than 1.5 to 1.

Better targeted support for exploration activity

The Government will better target the immediate deduction for assets first used in exploration. This will ensure that this important concession remains sustainable and continues to support genuine exploration activity.

Some companies have been claiming massive deductions for the costs of purchasing rights and information, the value of which reflects resources that have already been discovered.

This is not genuine exploration and should not get the concession.

The ATO has identified that over $11 billion worth of deductions have been claimed in this way in just 3 years, including several claims more than $1 billion.

Improving the integrity of our foreign resident CGT regime

The Government is also acting to improve the integrity of our capital gains tax (CGT) regime and boost compliance of foreign residents.

Let me be clear, the Government supports and encourages foreign investment — but foreign investors need to meet their tax obligations just like the rest of us. 

These changes will ensure that the CGT regime applies to foreign investors in the way it was intended and improve the collection of existing liabilities.

Closing loopholes in our Offshore Banking Unit regime

The Government will amend the offshore banking unit (OBU) regime to improve its integrity and attract genuine mobile banking activity.

These changes will prevent the use of related party transactions and other arrangements to shift profits into the concessional regime.

Improving the integrity and fairness of our Consolidation regime

The Government will improve the integrity and fairness of the Consolidation regime by implementing recommendations from recent reviews of the Board of Taxation.

This will provide a level playing field for businesses outside the consolidation regime.

The Government will also remove inconsistencies in the law and ensure that Australian consolidated groups compete on a level playing field with foreign-owned Multiple Entry Consolidated groups.

Preventing 'Dividend Washing'

Finally, the Government will close a loophole that allows sophisticated investors to engage in 'dividend washing'.

This will prevent these investors from claiming two sets of franking credits on what is essentially one set of shares.

This was an emerging loophole that threatened to erode our corporate tax base.

This package of measures responds to a range of identified flaws, gaps and weaknesses in our tax arrangements.

No responsible government can sit on its hands when confronted with these.  Indeed, protecting the integrity of our tax system is a fundamental duty of any government.

These measures build on reforms that the Government has already progressed to ensure our domestic laws apply appropriately, such as the modernisation of our transfer pricing laws and the reforms to the general anti-avoidance rule I talked about earlier.

Experience tells us that the corporate tax base is particularly vulnerable to tax planning that involves party dealings and corporate re-structures, especially when they're undertaken by multinationals across international borders.

Conclusion

Ladies and gentlemen, this conference has brought together some of the best minds in General Anti‑Avoidance Rules. 

My brief discussion about the Government's amendments to Part IVA currently before Parliament, and the broader context in which it operates serves simply as a starting point.

A starting point to hear your views and ideas on issues like how the rules operate in Australia and elsewhere, and how governments can use General Anti Avoidance Rules to protect our tax system for the benefit of the whole community.

With that, I'd like to declare this conference open and wish you all the best throughout today's sessions.

Thank you.