A tax consolidation regime applies for income tax and CGT purposes for Australian tax resident companies, partnerships, and trusts ultimately 100% owned by a single head company (or certain entities taxed like a company) resident in Australia. Australian resident companies that are 100% owned (either directly or indirectly) by the same foreign company and have no common Australian head company between them and the non-resident parent are also allowed to consolidate as a multiple entry consolidated (MEC) group. The group that is consolidated for income tax purposes may differ from the group that is consolidated for accounts or for GST purposes.
Groups that choose to consolidate must include all 100%-owned resident entities under an all-in rule, and the choice to consolidate is irrevocable. However, eligible tier-1 companies (being Australian resident companies that have a non-resident shareholder) that are members of a potential MEC group are not all required to join a single MEC group when it forms, but may form two or more separate MEC or consolidated groups, if they so choose, of which the same foreign top company is the 100% owner. If an eligible tier-1 company joins a particular MEC group, all 100% resident subsidiaries of the company must also join the group. While the rules for forming and joining MEC groups allow more flexibility than with consolidated groups, the ongoing rules for MEC groups are more complex, particularly for tax losses and on the disposal of interests in eligible tier-1 companies, which are subject to cost pooling rules, although for practical purposes these rules are relevant only if the non-resident’s interest is (or will become) an indirect Australian real property interest (see Capital gains in the Income determination section for more information).
A single entity rule applies to members of a consolidated or MEC group so that for income tax purposes the subsidiary members are taken to be part of the head company, while they continue to be members of the group and intra-group transactions are not recognised. In general, no group relief is available where related companies are not members of the same consolidated or MEC group. Rollover relief from CGT is available on the transfer of unrealised gains on assets, which are taxable Australian property, between companies sharing 100% common ownership where the transfer is between non-resident companies, or between a non-resident company and a member of a consolidated group or MEC group, or between a non-resident company and a resident company that is not able to be a member of a consolidated group.
Consolidated groups file a single tax return and calculate their taxable income or loss ignoring all intra-group transactions.
When a consolidated group acquires 100% of an Australian resident entity, so that it becomes a subsidiary member, generally the cost base of certain assets (in general, those that are non-monetary) of the joining member are reset for all tax purposes, based on the purchase price of the shares plus the entity's liabilities, subject to certain adjustments. In this way, an acquisition of 100% of an Australian resident entity by a consolidated group is broadly the tax equivalent of acquiring its assets. Subject to certain tests being passed, tax losses of the joining member may be transferred to the head company and may be utilised subject to a loss factor, which is broadly the market value of the joining member divided by the market value of the group (including the joining member). The value of the loss factor (referred to as 'the available fraction') that applies for transferred losses may be reduced by capital injections (or the equivalent) into the member before it joined, or into the group after the loss is transferred.
Franking credits and tax losses remain with the head company of the group when a member exits, and the cost base of shares in the exiting member is recreated based on the tax value of its assets at the time of exit, less liabilities subject to certain adjustments.
Generally, members of the group are jointly and severally liable for group income tax debts on the default of the head company, unless the group liability is covered by a tax sharing agreement (TSA) that satisfies certain legislative requirements. A member who enters into a TSA generally can achieve a clean exit from the group where a payment is made to the head company in accordance with the TSA.
Australia has a comprehensive transfer pricing regime aimed at protecting the tax base by ensuring that dealings between related, international parties are conducted at arm's length. The arm's-length principle, which underpins the transfer pricing regime, uses the behaviour of independent parties as a benchmark for determining the allocation of income and expenses between international related parties. Australia’s transfer pricing regime is in line with international best practice as set out by the OECD.
Transfer pricing adjustments operate on a self-assessment basis and apply in respect of certain cross-border dealings between entities and to the allocation of actual income and expenses of an entity between the entity and its PE, using the internationally accepted arm's-length principle, which is to be determined consistently with the relevant OECD Guidance material (and applied to both treaty and non-treaty cases). In addition, companies are required to have transfer pricing documentation in place to support their self-assessed positions before the lodgement of the tax return.
Australia implemented the OECD’s transfer pricing documentation standards for those companies that are part of a group with global revenue of AUD 1 billion or more. Under these documentation standards, the Australian Taxation Office (ATO) receives the following information on large companies operating in Australia:
- A country-by-country (CbC) report that shows information on the global activities of a multinational, including the location of its income and taxes paid.
- A master file containing an overview of the multinational’s global business, its organisational structure, and its transfer pricing policies.
- A local file that provides detail about the local taxpayer’s inter-company transactions.
The ATO has had a specific focus on transfer pricing of related-party cross-border financing, marketing, sales, and distribution arrangements in recent times and has adopted a compliance approach that will vary depending on the risk rating of a taxpayer’s specific related-party arrangement.
Thin capitalisation measures apply to the total debt of the Australian operations of multinational groups (including branches of those groups). The measures cover investment into Australia of foreign multinationals and outward investment of Australian-based multinationals, and, for income years that commence before 1 July 2023, they include a safe-harbour debt-to-equity ratio of 1.5:1. Interest deductions are denied to the extent that borrowing exceeds the applicable safe-harbour ratio. Where borrowing exceeds the safe-harbour ratio, multinationals are not affected by the rules if they can satisfy the arm's-length test (that the borrowing could have been borne by an independent entity). A further alternative test is available for certain inward or outward investing entities based on 100% of their worldwide gearing.
As mentioned above, the thin capitalisation rules apply to inward investment into Australia. This means they will apply where a foreign entity carries on business through an Australian PE or to an Australian entity in which five or fewer non-residents have at least a 50% control interest, or a single non-resident has at least a 40% control interest, or the Australian entity is controlled by no more than five foreign entities. Separate rules apply to financial institutions. To facilitate their inclusion in the rules, Australian PEs of foreign entities are required to prepare financial accounts.
In calculating the safe harbour debt, an entity must prima facie comply with the accounting standards in determining its assets and liabilities and in calculating the values of its assets, liabilities, debt and equity capital. International Financial Reporting Standards (IFRS), equivalents of which apply in Australia, make it more difficult for some entities to satisfy thin capitalisation rules. However, thin capitalisation law allows departure from the Australian equivalents to IFRS to exclude deferred tax assets and liabilities and surpluses and deficits in defined benefit superannuation funds from applicable calculations. It is not possible to revalue certain assets specifically for thin capitalisation purposes.
The Australian government proposes to remove the current safe harbour debt test for non-financial entities with effect for income years commencing on or after 1 July 2023 and replace it with a limit on debt deductions determined by reference to 30% of tax earnings before interest, taxes, depreciation, and amortisation (EBITDA) (referred to as a fixed ratio test). Deductions denied under the fixed ratio test will be able to be carried forward and claimed in a subsequent income year (up to 15 years) in certain circumstances. An additional test that can be chosen is a group ratio test, which will allow an entity in a group to claim debt-related deductions up to the level of the worldwide group’s net interest expense as a share of group earnings (this test will replace the worldwide gearing ratio). A new third-party debt test will replace the arm's-length debt test, and, if chosen, will limit debt deductions to an entity's external third-party debt only.
Controlled foreign companies (CFCs)
Under Australia’s CFC regime, non-active income of foreign companies controlled by Australian residents (determined by reference to voting rights and dividend and capital entitlements) may be attributed to those residents under rules that distinguish between companies resident in 'listed countries' (e.g. Canada, France, Germany, Japan, New Zealand, the United Kingdom, and the United States) and in other 'unlisted' countries. In general, if the CFC is resident in an unlisted country and it fails the active income test (typically because it earns 5% or more of its income from passive or tainted sources), the CFC's tainted income (very broadly, passive income and gains, and sales and services income that has a connection with Australia) is attributable. If a CFC is resident in a listed country, a narrower range of tainted income is attributed even if the CFC fails the active income test.
When income previously taxed on attribution is repatriated, it is not assessable for tax.
Integrity measures for large multinationals
The following integrity measures seek to address multinational tax avoidance by entities that, in broad terms, are 'significant global entities' (SGEs) and/or ‘country-by-country reporting entities’ (CbCREs); broadly entities that are part of an actual consolidated accounting group or notional consolidated accounting group (determined by assuming that each member of the group were a listed company and disregarding certain exceptions for preparing consolidated accounts) with global revenue of AUD 1 billion or more (see below):
- Transfer pricing documentation standards applicable to a CbCRE.
- The doubling of the maximum administrative penalties that can be applied to entities that enter into tax avoidance and profit shifting schemes.
- A targeted anti-avoidance rule aimed at multinationals that enter into arrangements that artificially avoid having a taxable presence in Australia. Specifically, this measure will ensure that profits from Australian sales are taxed in Australia where the activities of an Australian associated entity support the making of those sales, and the profit from the Australian sales is booked overseas and is not attributable to a PE of the foreign entity in Australia. A principal purpose of entering into the arrangement must be to create a tax benefit.
- A requirement for a CbCRE to lodge general purpose financial statements (GPFS) with the ATO where such accounts are not already lodged with the Australian Securities and Investment Commission.
- A Diverted Profits Tax (DPT) that is imposed at a penalty rate of 40% in circumstances where the amount of Australian tax paid is reduced by diverting profits offshore through contrived related-party arrangements. The DPT is extremely broad (for example, both financing and non-financing arrangements are in scope).
- Significantly increased penalties (from 1 January 2023 as great as AUD 687,500, or more following indexation on 1 July 2023) that can be applied for failing to lodge a tax return (or other tax-related document) on time.
- Doubling of penalties that can be applied for making a false or misleading statement.
The Australian government proposes a range of additional measures targeted to large multinationals, including:
- Denial of tax deductions for payments made from 1 July 2023 by an SGE directly or indirectly to related parties in relation to intangibles held in low- or no-tax jurisdictions (i.e. in broad terms, those with a tax rate of less than 15% or which have a tax preferential patent box regime without sufficient economic substance).
- Requiring the public reporting of certain tax information on a country-by-country basis, and a statement on their approach to taxation, for disclosure by the ATO proposed to apply from 1 July 2024.
Hybrid mismatch rules
Australia has comprehensive hybrid mismatch rules. Hybrid mismatches are differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions. If a mismatch arises, the law operates to neutralise the mismatch in Australia by:
- Preventing entities that are liable to income tax in Australia from being able to avoid income taxation, or obtain a double non-taxation benefit, by exploiting differences between the tax treatment of entities and instruments across different countries by disallowing a deduction or including an amount in assessable income.
- Limiting the scope of the exemption for foreign branch income and preventing a deduction from arising for payments made by an Australian branch of a foreign bank to its head office in some circumstances.
- Denying imputation benefits on franked distributions made by an Australian corporate tax entity if all or part of the distribution gives rise to a foreign income tax deduction; and preventing certain foreign equity distributions received, directly or indirectly, by an Australian corporate tax entity from being exempt if all or part of the distribution gives rise to a foreign income tax deduction.
In addition, there is an integrity rule that has the potential to impose additional Australian tax on interest and derivative payments to foreign interposed zero or low-tax rate entities, irrespective of whether the arrangement involves a hybrid element.