On 31 March 2023, the Treasury released exposure draft legislation relating to proposed new rules designed to limit significant global entities – entities with global revenue of at least A$1 billion (SGEs) – from claiming deductions for payments made to associates in respect of intangibles that derive income in jurisdictions with a corporate tax rate of less than 15% (referred to in the draft legislation as low corporate tax jurisdictions).

This was foreshadowed in the 2022/2023 Federal Budget released in October last year and comes two weeks after exposure draft legislation for proposed changes to the thin capitalisation rules was released. The measures are consistent with the Government's legislative agenda to limit deductibility for payments which are perceived to erode the Australian tax base.

The proposed amendments introduce a new anti-avoidance rule to prevent multinational organisations from claiming tax deductions in Australia for payments linked to offshore intangible assets held by associates. The proposed amendments apply to payments or credits made to associates, and liabilities incurred from associates, by SGEs from 1 July 2023.

The Government has stated that arrangements involving payments to offshore associates holding intangible assets have been specifically focused on as:

• SGEs have significant scope as to how they structure their businesses, and it is common to centralise functions and assets and then charge subsidiaries for the use of these services or assets; and
• intangible assets are readily mobile, allowing them to be located in jurisdictions with low or preferential patent box regime tax rates.

The explanatory materials further comment that SGEs may also mischaracterise payments made for the right or permission to exploit an intangible asset, and they may enter into related-party arrangements that involve the provision of services from a related party and the right or permission to exploit an intangible asset.

The purported mischaracterisation of the payment typically results in royalty withholding tax not being paid and the taxpayer not recognising any part of the payment as being a royalty for the use of the intangible asset.

Summary of proposed changes

The Bill modifies the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) to introduce new section 26-110. The proposed operative provision – section 26-110(2) - broadly states that a SGE cannot deduct an amount for a payment made to its associate (referred to as the recipient) to the extent that the payment is attributable to a right to exploit an intangible asset, if:

• as a result of the arrangement under which the SGE makes the payment, or any related arrangement, the SGE or its associate either acquires or exploits (or acquires a right to exploit) the intangible asset; and
• the entering into of the arrangement (or related arrangement), or the acquisition, exploitation or acquisition of the right of exploitation of the intangible asset, results in the recipient (or another associate) deriving income in a low corporate tax jurisdiction.

In interpreting section 26-110:

• The terms 'SGE' and 'associate' rely on their respective definitions in section 960-555 of the ITAA 1997 and s 318 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936), respectively.
• The phrase 'exploit an intangible asset', which is the gateway into the operation of the provision, is defined in section 26-110(9) broadly, and captures, among other things, the use of, marketing, selling and distributing the intangible asset. The breadth of section 26-110(9) is also accentuated by including the doing of "anything else in respect of the intangible asset" in the definition. The phrase also includes an implicit permission or understanding to exploit an intangible asset.
• The definition of 'intangible asset' includes traditional intellectual property rights, such as copyright, patents and trademarks, but has been broadened for the purposes of section 26-110 to also include rights with respect to intellectual property assets, such as access to customer databases, software licences and algorithms.
• 'Low corporate tax jurisdiction' will be defined to mean a foreign country where the rate of corporate income tax under its laws is less than 15%, or if the Minister determines that the foreign country provides for a preferential patent box regime without sufficient economic substance. Patent box regimes are regimes that typically provide tax concessions (usually in the form of concessional tax rates), for income derived from the exploitation of intellectual property. Examples of foreign countries with patent box regimes include the Republic of Ireland, Cyprus and Luxembourg.

Who is impacted?

Similar to other anti-avoidance rules such as the diverted profits tax, this new anti-avoidance rule will only apply to SGEs, although entities which are not SGEs that have similar arrangements should review their arrangements in light of other existing integrity rules, such as Part IVA.

The scope and proposed drafting of the proposed changes are potentially very broad but the key condition includes a cross border deductible payment or credit from an Australian entity to an associate in a low corporate tax jurisdiction that essentially is linked to an intangible asset held in that jurisdiction. Any SGE that has established an offshore IP holding entity may be impacted.

The explanatory materials also state that the exploitation of an intangible asset includes a right or obligation to distribute products on behalf of an associate that involves marketing, selling or distributing the intangible asset, even when the intangible asset (e.g. software) is distributed directly from the offshore associate to the customer. Thus, common buy/sell or agency arrangements may be caught.

The proposed changes however contains a key exception for what the explanatory material refer to as genuine supply and distribution arrangements between associates where there is no tax avoidance behaviour. The proposed changes carve out these types of arrangements by excluding an intangible asset that is, perhaps confusingly, a right in respect of, or an interest in, a tangible asset. This appears to be intended to be broad enough to capture arrangements such as the genuine use of trademarks printed on finished goods that are marketed and sold by an SGE to customers.

The explanatory materials suggest that the exception would only cover arrangements that do not extend beyond the mere marketing and selling of those finished goods. SGEs which have entered into arrangements with offshore associates that hold IP will need to carefully review all relevant documentation and transfer pricing benchmarks with a view to supporting any deductions being claimed in Australia which are referable to those arrangements.

Next steps

The Government has sought comments on the Exposure Draft by 28 April 2023. Once those comments have been considered, the Exposure Draft will be converted into a Bill for introduction into the House of Representatives.

Whether there will be enough time for the Bill to be introduced and passed by its intended start date of 1 July 2023, or whether it will take effect retrospectively, or be deferred, remains to be seen.

Please get in touch with our team if you need assistance in navigating the proposed new measures.