At first blush, treaty shopping might sound like a fun excursion to the gift store with your primary schooler. Yet far from being a pleasant way to spend a Sunday afternoon, treaty shopping is a worrisome lurk that undermines the tax system.
On July 20, the tax office released an alert about a high-risk activity that has been observed and will be subject to increased scrutiny: companies restructuring their tax affairs to take advantage of reduced withholding tax rates under a tax treaty in relation to royalty or dividend payments from Australia. As the it noted, such a restructure might involve creating a new entity in a favourable treaty jurisdiction, interposed between the foreign parent and the Australian operation in order to access the reduced tax rates under the tax treaty.
Treaty shopping is just one of the tax avoidance practices that have caught the fancy of multinationals. Apple pioneered ‘Leprechaun Economics’. Microsoft used a trick known as the ‘Single Malt’. Google and Facebook once used the ‘Double Irish with a Dutch Sandwich’. The tricks have been exposed through the Luxembourg Leaks, Panama Papers, Pandora Papers and Paradise Papers. These data dumps have shown how high-wealth individuals and corporations with questionable ethics sought to minimise tax through their dealings in low or no tax jurisdictions.
The previous government talked a big game about multinational tax dodging, but didn’t do enough. That’s why Labor went to the election with a plan to ensure multinationals pay their fair share of tax. This isn’t just about securing the revenue base; it’s also about putting local firms on the same footing as multinationals. How can a local retailer compete with a tax-dodging multinational?
Part of the plan that Labor took to the election was to provide greater integrity over payments for intangibles, limiting the ability of large multinationals to avoid Australian tax by funnelling payments for intellectual property to or through low or no tax jurisdictions. Other countries have taken action to close this loophole, but under the former government, Australia failed to do so.
Among thoughtful business leaders, there is a growing recognition that high-risk tax practices can often backfire. When Starbucks UK was revealed to have paid no company tax for three years running, it suffered a consumer boycott. The company eventually volunteered to pay £10m ($17.3m) a year in taxes for the next two years in an attempt to win back disgruntled customers.
For Amazon, who have battled tax authorities across the world, it’s not just customers but shareholders who are calling for change. At their most recent annual meeting, major investors brought forward a proposal for the company to join the Global Reporting Initiative. This would require Amazon to start reporting publicly on their revenues and tax payments in every country they operate in. Although Amazon is yet to take action on this, BHP and Rio Tinto have already signed up – welcoming the additional scrutiny of their activities across the planet.
Well-run companies recognise that paying tax isn’t an optional extra; it’s part of a firm’s social license to operate. When the government scrutinises foreign investment applications, it considers the investor’s tax arrangements and whether they’re using structures designed to avoid Australian tax liabilities. Investment in Australia can create jobs and raise wages – but that shouldn’t come at a cost to the tax base.
The OECD has taken action to address treaty shopping through Action 6 of the OECD/G20 Base Erosion and Profit Shifting Project, which requires tax treaties to include integrity rules to prevent treaty shopping.
Among these changes, treaties are now required to include integrity rules for example, the Principal Purpose Test to deny taxpayers the benefit of the treaty if they have entered into an arrangement with a principal purpose of obtaining treaty benefits. Tax treaties are now also required to make clear that they are intended to avoid instances of double non-taxation (not paying tax in either country), as well as double taxation (paying tax in both countries).
Australia has implemented these integrity rules by ratifying the OECD’s Multilateral Instrument. These integrity rules now apply in about half of Australia’s tax treaties, and this number will continue to grow each year as more of our treaty partners ratify the Multilateral Instrument. These tools, coupled with enhanced exchange of tax information arrangements, are now becoming available to the ATO to address instances of tax treaty abuse.
There’s nothing inherently wrong with large firms. Sometimes scale can benefit consumers, as companies use their size to drive down retail prices. Wages tend to be higher in larger companies, and multinationals can sometimes inject a dose of competition into the local market. But when firms use their size to gain an unfair tax advantage over their smaller rivals, bigness turns into bullying. Multinationals should prosper because they’re offering better products and cheaper prices – not because they’re exploiting a tax lurk.
