Intangibles in the Outback

When it comes to Australians, I think most Americans imagine them to either be like Cate Blanchett–classy, slightly edgier Brits–or, basically, Crocodile Dundee.

The truth is that Australia bears a lot of resemblance to the United States. (Except it’s actually more urbanized, with nearly 90% of the population living in cities.) But perhaps one unique characteristic of the Land Down Under is its economy’s reliance on mining and other resource extraction. It’s one of the few countries to beat the resource curse, managing to recapture most of the value from the land’s riches even as foreign firms do most of the harvesting. (That gets into the history of exploitation in British colonies–not exactly my area.)

This may explain Australia’s distinct approach to international taxes. The country has long been sensitive to the possibility of tax avoidance by non-Australian companies, and has been unusually aggressive in targeting what it sees as offshore tax havens. While the rest of the world was experimenting with digital services taxes, Australia enacted a Diverted Profits Tax and the Multinational Anti-Avoidance Law (now at the center of a massive accounting scandal) to try to block any means of deriving economic value in the country without generating taxable income. It has also pioneered an innovative approach with “practical compliance guidelines,” that may help with taxpayer compliance but also demonstrate the tax authority’s focus on offshore “hubs,” be they used for shipping, distribution or marketing.

As I wrote earlier this month, it’s set to enact the world’s most transparent tax reporting rules.

And it recently released a new proposal to try to better target transactions involving valuable intangible property, like intellectual property. The provision perhaps bears a slight resemblance to anti-avoidance rules used in Europe, that target deductions for outbound related-party payments. But it goes much further than any other rule I’m aware of, essentially trying to impose a 15% minimum tax on any royalty income in the world that has a connection to Australia.

It’s provoked a harsh backlash among business groups, who claim that the tax isn’t only unfair and potentially destructive, but also unnecessary. Why try to enact your own 15% minimum tax, as the G-20 and Organization for Economic Cooperation and Development implement their 15% global minimum tax, as part of a multilateral tax initiative that Australia was a part of? And, for that matter, will duplicate many of the other rules that Australia has already enacted?

I’ve written in the past about the trend towards blunt, formulaic enforcement rules in international taxes that try to work as a backstop to the more principles-based traditional system. Rather than try to carefully refine definitions to capture exactly the transactions that are causing problems–often in the ethereal realm of online commerce or tech–just focus on proxies for that income based on factors we can more easily see and identify, like tangible assets or employees.

Australia has followed this trend in the past. The practical compliance guidelines that I mentioned earlier are often based on profit margins–hit a certain margin on transactions and you’re much less likely to be audited.

But its most recent rule is the direct opposite. It doesn’t go after proxies of intangibles, it tries to hit the intangibles themselves. Which, according to the critics, will cause a lot of uncertainty and enforcement difficulties in practice.

The rule is still just a proposal, and the government is currently considering comments. But whatever comes of it, the kerfuffle demonstrates some of the key issues and questions between these two basic philosophies for international taxes.

The provision will work by targeting deductions that a multinational group takes in Australia, that are for payments “to associates in relation to exploiting intangible assets connected with low corporate tax jurisdictions,” according to draft commentary from the Australian Treasury. It’s not the only deduction denial scheme in the world–many European countries have similar anti-abuse rules, and it’s also the basis for the U.S. base erosion and anti-abuse tax. (It was also the original idea behind the Organization for Economic Cooperation and Development’s under-taxed profit rule, but it ultimately grew well beyond that.)

The issue, according to critics, is how the law defines both intangibles and royalty income. The Australian Treasury admits its definitions are “broad,” in order to “capture the variety of ways in which intangible assets can be exploited in the businesses” of multinationals. It includes a list of potential examples–intellectual property, algorithms, access to customer databases–while also giving the Australian Taxation Office wide latitude to make its own determinations.

Royalty income is also defined in way that will likely capture many types of transactions not typically considered royalties. The Treasury admits this–it states that ”mischaracterizing payments that are, at least to some extent, effectively made to acquire a right or have permission to exploit an intangible asset as payments made for other things such as services or tangible goods, will not avoid the operation of this anti-avoidance rule.”

Business groups claim that this will lead to a lot of mis-application.

"It will apply to genuine commercial arrangements that do not involve any mischief and would impose completely unwarranted compliance costs on those taxpayers," wrote Corporate Tax Association, an Australian industry group. "The [proposed rule] affords no scope for reasonable or rational consideration of relevant circumstances."

The National Foreign Trade Council, based in the U.S., said it could ultimately affect “virtually every sale into Australia.”

“In substance, this appears in form to closely align conceptually with a destination-based cash flow tax, not an income tax, for any conceivable connection with intangibles,” the NFTC wrote in an open comment to the Australian tax authority.

The definition of intangibles has always been a tricky part of international taxes and transfer pricing. You have IP such as patents or trademarks, that have been legally registered. Then you have more nebulous things like information and “know-how,” or trade secrets that a company hasn’t registered as IP because it doesn’t want its competitors to know about it. Recent court cases have examined things like going-concern, the extra value of a business that is up-and-running, or goodwill, a kind of vague concept relating to a company’s positive perception beyond its trademarked brand value. Emerging market countries like India have argued that things like “location savings” need to be taken into account as well.

In some cases, it doesn’t always matter what an intangible is defined as, so long as its value is recognized. In others, billions of income allocations may hinge on it.

Indeed, one of the reasons for the Australian proposed rule is that, the government alleges, companies had discovered ways to circumvent the royalty definitions in its current withholding taxes. That’s why broader, all-encompassing definitions were needed.

The Australian proposal reminded me a bit of U.S. Subpart F rules, that are designed to sweep in foreign royalty income and tax it at the full corporate tax rate. There are two key differences, however. Subpart F only applies to companies based in the U.S., which gives the government a little more leverage than if they were trying to tax offshore income only connected to the jurisdiction through a subsidiary or branch. And Subpart F hinges on whether royalties are active or passive–another definitional rule, but one that has had a long history of use.

Of course, formulaic rules cause mis-applications too, almost by definition. Many companies have been swept up by the tax on U.S. global intangible low-taxed income simply because of their business model, not due to nefarious planning. But the “rough justice” approach can at least be more predictable for taxpayers, not hinging on precise definitions.

The drawn-out history behind these Australian rules–they began in 2022 and already had a public consultation on an earlier (and very different) version–demonstrates the difficulty of coming up with definitional rules that are broad enough to hit the target, but narrow enough to limit collateral damage.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• Republicans on the House Ways and Means Committee unveiled Thursday legislation to retaliate against countries which enact parts of the OECD's 15% global minimum tax that would hit U.S. firms. For practical matters, this would mean that individuals and corporations from countries that enact the UTPR could be subject to tax rates hikes of as high as 20 percentage points. The legislation itself doesn't stand much of a chance of being enacted as-is, but as a declaration of war from the GOP it's notable. There are already provisions, like Section 301 and the more obscure Section 891, that a Republican president could use to initiate similar retaliations against countries following the OECD plan, if the president so choses. This is yet another escalation in rhetoric in the House GOP's campaign against the OECD. But perhaps their reported delegation to meet with officials from the organization in Paris next week could smooth things a bit.
• The International Accounting Standards Board finalized some new provisions to international accounting rules to help companies report some of the new tax considerations arising from the OECD project to shareholders. These include a temporary patch for calculating timing issues as well as some targeted disclosure rules for how to report new tax liabilities. This is likely an early step towards meshing standards to the OECD system, which is likewise based on financial statement income in a complicated back-and-forth.
• Speaking of the OECD, its efforts to stamp out international corporate tax avoidance often outshines its other tax work--such as the paradigm-shifting tax transparency rules developed by its Global Forum on Transparency and Exchange of Information for Tax Purposes. They've recently bolstered their efforts in Asia, announcing Monday that the Asian Infrastructure Investment Bank and Study Group on Asia-Pacific Tax Administration and Research as observers. They'll join institutions such as the United Nations, World Bank, International Monetary Fund, and African Tax Administration Forum.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Captain Comet, who debuted in Danger Is Our Business #1 in 1953. Commander of Starhope, an "interplanetary space liner," Captain Comet heroically fought off space pirates, mainly armed with a ray gun.

Contact the author at amparkerdc@gmail.com.

NOTE: This newsletter will be off next week, and will return the week of June 5.