I certainly would not want to be seen as an apologist for multinational company groups in the current debate on what to do about profit-shifting tax avoidance activities of groups like Google and Apple.
But there are some significant legal/technical obstacles in the way of solutions.
Like other countries, Australia taxes each company in a group on the basis of where it is resident. An Australian resident is liable here on its worldwide income, but a foreign resident is taxed by Australia only on income with an Australian “source”. Put simply, profits have a source where the activity that generates the relevant income is located.
Our taxing rights are affected by the some 40 legally-binding (but terminable) tax treaties that Australia has with other countries. They are part of a world-wide net of such treaties, based on an OECD model. One key rule is that Australia can’t tax the business profits of a company resident in a treaty country unless it has a “permanent establishment” (PE) here. The concept of “permanent establishment” and the terms in which it is expressed –“ a fixed place of business”- were formulated in pre-information technology “old world” days of bricks and mortar, when there was a clear physical place where income producing activity was carried on.
In defined circumstances an agent in Australia of a foreign company could be a PE of that company, eg if the agent had authority to conclude contracts on its behalf. However with the availability and speed of technology, and no doubt readily available structuring advice, it is not difficult for groups like Apple and Google to so arrange things that their subsidiary that is drawing income from Australia does not have (for them) unwanted PE status.
The OECD /G20 is looking at this, with (as far as can be seen) attention being given to to patching up the agency rules. International consensus on changes, followed by bilateral or multilateral treaties and domestic enabling legislation is likely to be a drawn out affair. I am not holding my breath. How readily will the US sign on to measures that cause its companies to pay more foreign tax?
The UK (with a coming election) is going alone, despite OECD criticism, with its own “diverted profits tax” to address the exploitation of treaty provisions. Is Australia to follow with a similar unilateral approach? If one says that profits are diverted there must be a status from which the diversion takes place. If that status is determined by the existing “old world” tax treaties the UK approach might involve going around in circles. Also, each tax treaty has a standard provision that requires that its rules and limitations apply also to any later substantially similar taxes imposed in addition to the existing taxes.
On a different tack, let’s look at what a customer in Australia pays for an Apple device. We have been given to understand that this dealing is with a Singapore subsidiary that does not have a PE in Australia. Even if it did, only a small part of sales receipts would properly be taxable here. The devices are manufactured in another country and employ foreign- developed technology for which some royalty expense can properly be charged. Achievement of sales does not require a big marketing effort in Australia. We in Australia would think it inappropriate if China were to say that the whole or a substantial part of an Australian company’s receipts from the export to that country of Australian iron ore or coal was a profit made in China.
Turning to Google, if you place one of the ads from which it makes its money you are, apparently, dealing with a Singapore subsidiary that does not have a PE in Australia (see above).Courtesy of the technology you may be interacting with a computer or human being in another country/ countries. These days, that is not all that strange – when we ring up about a phone problem we can find that we are speaking to someone in the Philippines who can deal with it from there. A bank matter may involve use of a person in India. A daily newspaper finds it cheaper to have its sub editing done in New Zealand. In other words, use of overseas-located technology does not in itself speak of tax avoidance.
Coming at it another way, however, Google’s advertising service offered to Australians does have an Australian character. Technically though, it is a business profit shielded from Australian tax by the PE rule. In 1968, faced with a similar inability to tax know-how and other like payments we developed a new definition of “royalty” , gave royalties a statutory “source” in Australia where they are paid by an Australian resident or are an expense of a “permanent establishment” here. Without exception, we excluded them from the PE rule in all subsequent treaties.
The US itself, home to major multinationals, is necessarily part of any solution. A US parent is taxed there on foreign subsidiary profits remitted home as income, credit being allowed for foreign tax paid. Profits diverted into tax haven subsidiaries and not paid up to the parent are not taxed , although they are available for group use. In 1962, “controlled foreign corporations” laws were introduced to tax parents on income so diverted. (BHP has said that it pays our CFC tax on income of its Singapore marketing company.) However, the US protective rules have major loopholes which Congress has not seen fit to close. Seemingly, the US prefers the extra tax-free clout that the loopholes give to their corporations over the contribution to its revenue that effective taxation would achieve.
Were the US to tax effectively, US groups would (because of availability of credit for foreign tax paid) have less incentive to avoid Australian and other foreign taxes.
The Government’s discussion paper would have us believe that a reduction in Australia’s company tax would lessen avoidance incentives. Well, for companies addicted to tax minimisation it would have to be a very big reduction. A reduction in our rate would do two things: for Australian-resident shareholders it would mean smaller imputation credits and thus more personal tax, while for foreign shareholders the benefit would accrue to them or the Treasury of their country.
It’s not easy.
Trevor Boucher was Australian Commissioner of Taxation 1984-93. This was followed by two years as Australia’s Ambassador to the OECD.