The Australian Tax Office’s unique approach to profit attribution and the implications for permanent establishments in Australia

Craig Silverwood

MinterEllison, Melbourne

Craig.Silverwood@MinterEllison.com

Beau Jellis

MinterEllison, Melbourne

Beau.Jellis@MinterEllison.com

Elissa Romanin

MinterEllison, Melbourne

Elissa.Romanin@MinterEllison.com

The Australian Taxation Office (ATO) persists in adopting a method for attributing profits to permanent establishments (PEs) that is misaligned with international standards. This divergence may result in foreign taxpayers encountering a tax burden in Australia that is considerably more substantial than they might have anticipated. In the article that follows, we examine the ATO’s methodology and explain why it can often culminate in an unusually high tax imposition on PEs within Australia.

The ATO’s approach

Australia’s PE attribution rules are outlined in subdivision 815-C of the Income Tax Assessment Act 1997 (Cth). These rules act to effectively tax PEs in Australia on an amount that is not less than what would be taxed if the PE were a distinct and separate entity engaged in similar activities in comparable circumstances. These rules are based on the ‘relevant business activity’ and ‘single entity’ approaches, which require the allocation of actual income and expenditure of the entity to the PE.

The Organisation for Economic Co-operation and Development’s (OECD) approach

This approach differs significantly from the ‘authorised OECD approach’ (AOA), which allows for separate remuneration of dealings in accordance with the arm’s length principle, without necessarily relying on the allocation of actual income and expenditure. The AOA can also permit additional adjustments to align with the arm’s length profit, even if the actual expenditure cannot be identified. This fundamental difference in approach can have substantial implications for multinational companies with a permanent establishment in Australia.

The situation in Australia

For multinational companies, the requirement to attribute actual income and expenses can lead to a higher attributed profit in Australia compared to the arm’s length conditions. This often results in additional taxation domestically and potential double taxation in other jurisdictions. The inability to reduce the taxable amount in Australia can create a significant financial burden for these companies.

In practice, while it may be relatively straightforward to attribute income, identifying sufficient actual expenses to align with the arm’s length return can be challenging. For example, a multinational company might be able to attribute a portion of its income from a specific business segment to its Australian PE. However, pinpointing the actual expenses incurred by the PE to generate this income can be more complex. This mismatch between attributed income and actual expenses can lead to a higher taxable amount in Australia, with no mechanism to reduce this Australian tax liability. Securing Effective Mutual Agreement Procedure relief of any double tax is also challenging, particularly in circumstances where Australia’s treaty partner respects the AOA and Australia does not.

Furthermore, the income and expenses allocated to the Australian PE may have additional tax implications that are contingent on the character of the allocated transactions. For instance, during the profit allocation process, any expenses attributed to the Australian PE that are characterised as ‘royalties’ may be subject to Australian royalty withholding tax.

Moreover, the requirement to attribute actual income and expenses can create additional administrative burdens for multinational companies. Companies must maintain detailed records of their income and expenses to comply with Australia’s profit attribution rules. This can be time consuming and costly, particularly for companies with complex business structures and operations in multiple jurisdictions.

To mitigate these challenges, multinational companies may need to develop strategies to comply with Australia’s profit attribution rules, while minimising their tax liability. This may involve developing transfer pricing protocols to ensure an appropriate approach to attributing income and expenses to the Australian PE. For example, companies may need to conduct detailed analyses of their business activities and expenses to ensure that they can accurately attribute income and expenses to the PE. They may also need to consider restructuring their operations or business models to align with Australia’s profit attribution rules.

Conclusion

In conclusion, Australia’s profit attribution rules can have significant implications for multinational companies with a permanent establishment in Australia. The requirement to attribute actual income and expenses can lead to a higher attributed profit and additional taxation domestically, as well as potential double taxation in other jurisdictions. Multinational companies must carefully consider these implications to develop strategies to comply with Australia’s profit attribution rules, while minimising their tax liability. By doing so, they can navigate the complexities of Australia’s tax system and ensure that they are not unduly burdened by additional taxation.