Towards a fair, competitive and sustainable corporate tax base
Address to ICAA National Tax Conference, Hilton Sydney
Thursday 22 November 2012
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Thank you for that kind introduction and for the opportunity to talk with you today.
It's a pleasure to present the opening address to this year's National Tax Conference of the Institute of Chartered Accountants Australia.
Let me begin by acknowledging the significant contribution that the ICAA makes to the public policy debate in this country on tax and related matters.
Today, I would like to discuss the importance of securing a fair, competitive and sustainable tax base for the future prosperity of the nation.
Tax is the price we pay for a civilised society.
It is a central element of the social contract.
In return we expect that Governments will deliver the public goods and services we require- like world class health and education systems, a strong social safety net and public infrastructure.
Against this backdrop, we have set out our vision for a tax system that enhances productivity and lifts growth; that encourages participation and provides reward for effort; and a system that is fair and sustainable.
Pressures on the Corporate Tax System
Today I want to talk about some emerging structural changes occurring in the global economy, such as what some call the 'digital disruption'- and how these changes present challenges that, if left unchecked, threaten to erode Australia's corporate tax base.
While our economy is now around 11 per cent larger than it was when we came to office and economic activity has returned to trend growth, tax revenues have been slower to recover.
This can in part be attributed to the use of accumulated losses, incurred during the GFC, to offset tax payable on income in the last few years.
Of greater concern are some of the emerging threats to the corporate tax base posed by some of the structural changes in the global economy, which are being exacerbated by some of the more recent tax planning practices of many Multinational corporations.
Effective Tax Rates of Multinational Enterprises
One of the ways of assessing pressure on the corporate tax system is to estimate the effective tax rates of companies. That is, to compare the actual tax paid with the underlying income earned.
At its simplest, when taxable income is the same as the underlying income, then the effective tax rate will equal the statutory tax rate.
There are also situations where Governments will explicitly decide to provide preferential tax treatment and, in these cases, this will mean that the effective tax rate will be less than the statutory tax rate.
However, other explanations for low effective tax rates are not so benign.
In particular, where low effective tax rates reflect the ability of companies to shift income to low or no tax jurisdictions.
Internet, Knowledge Capital and the Corporate Tax Base
It is not my usual practice to mention companies by name or to publicly canvass the tax position of particular taxpayers. Nor is it my normal practice to publicly discuss strategies employed to minimise corporate tax.
However, I will be departing from my usual practice today as I believe there is a strong public interest in drawing attention to practices that have the potential to undermine the future sustainability of Australia's corporate tax base.
I must stress that all of the material used in this speech today has been sourced from the public domain. I also want to be clear that I am not suggesting that these companies are in breach of the law as it stands.
Many of you would have seen media reports on the level of tax paid by Google Australia.
Earlier this year it was reported that Google Australia's annual income tax bill may have been as little as $74,176. The same article reported that a spokesman for Google asserted that the correct figure was $781,471.[i]
Even if the higher figure is correct, I can understand why many in the community would be perplexed to learn that this figure is so low for a company whose annual advertising revenue from Australia has been estimated by media analysts to be over $1 billion per annum.[ii]
It has been reported that this is the outcome of an arrangement called the "Double Irish Dutch Sandwich".[iii]
While the day-to-day dealings of Australian firms advertising on Google might be with Google Australia, under the fine print of contracts Australian firms sign with Google, they are actually buying their advertising from an Irish subsidiary of Google.
It is then argued that the source of this income - and therefore the taxing rights under our tax treaty - would be with Ireland rather than Australia.[iv]
Despite Ireland's relatively low company tax rate of 12.5 per cent, we have just started to build the sandwich.
The next step is to route a royalty payment from the Irish operating subsidiary of Google to a Dutch subsidiary of Google, which is then paid back to a second Irish holding company subsidiary of Google that is controlled in Bermuda, which has no corporate tax.
That completes the sandwich - now for the tax treatment.
The first Irish subsidiary receives a tax deduction for the royalty payment to the Dutch subsidiary, substantially reducing the income subject to the 12.5 per cent Irish company tax rate.
Under Dutch law, and because EU member countries do not charge withholding taxes on transfers within the EU, the transfers to and from the Netherlands are essentially tax free.
And under Irish tax law, the second Irish resident subsidiary is not taxed on the royalty payment because it is controlled by managers elsewhere.
The profits from the sale of advertising to an Australian firm then sit in a tax-free jurisdiction - possibly indefinitely.
The point of all of this is not to single out Google for criticism. Google is an important innovator and plays a significant role in our economy, and they have engaged with the Government constructively on many issues- most recently through the Digital Economy Forum.
The media usually attributes the origins of this technique to Apple,[v] who reports earlier this year indicated had around $100 billion in cash, with about two thirds of that sitting in offshore accounts.[vi]
Nor is it my point that this structure is the only pressure facing the corporate tax system.
Rather, the point is to highlight how the digital disruption brought about by the internet and changes in technology have transformed the way economic activity is occurring- and these changes are putting pressure not only on businesses but also on the corporate tax system in Australia and around the world.
In turn, this challenges some of the concepts that form the building blocks of our current international tax architecture - source, permanent establishments and residency.
Increasingly, Governments are discovering the lack of effectiveness in the digital age of international tax concepts created for the industrial age.
This has been highlighted by the compelling evidence revealed by the UK Public Accounts Committee examination of the Taxation of Multinational Corporations.
Media reports of the Committee's hearings state that Amazon paid no tax in the UK despite £3.3billion in sales by routing transactions through Luxembourg, where it faced an effective tax rate of 2.5 per cent.[vii]
And now we see that the weaknesses that technology companies have exposed in the international tax architecture are spreading to other industries and activities.
The UK Public Accounts Committee was told that Starbucks had paid no taxes in the UK for three years, despite sales totalling £1.2 billion - in part due to royalty payments for the use of the brand.
What is being done about this?
I think some executives of multinational enterprises have been taken aback by the response to these reports from the broader community.
I have to say that it is no surprise to me that these reports have sparked community concern.
Many in business reject the notion that paying a fair share of tax forms part of a broader social compact, instead believing that it is just another cost of doing business.
On this point, I vehemently disagree.
These businesses benefit from operating in an economy built on social and economic institutions- our markets and regulators, the rule of law and our judicial system- not to mention physical infrastructure and human capital that is funded or supported by the taxes paid by others.
Where some multinational businesses enjoy the benefits of these public goods but refuse to pay their fair share, they are free riding on efforts of others.
Whether it is a domestic company put at a competitive disadvantage because it is paying tax on all of its profits.
Or whether it is Australian families that are expected to pay higher taxes or accept fewer Government services.
Losing sight of this perspective risks a community- and consumer- backlash, particularly at a time when the rest of the community is being asked to make sacrifices in the interests of fiscal sustainability.
Nevertheless, having laid out these issues, the natural question to me as Assistant Treasurer is "what are you, the Government, going to do about it?"
Some might argue that the solution is to cut the corporate tax rate and reduce the incentive to shift profits.
But when multinational companies can achieve effective tax rates of a few per cent - or even zero - trying to compete with these rates is no different to abandoning our corporate tax base.
This kind of international 'race to the bottom' is not protecting the sustainability of the tax system- it's just cutting out the creativity required to avoid paying company tax in Australia.
If enormous multinational corporations aren't paying their fair share of tax on economic activity in Australia, then that's not fair game.
We do not want to see a future where hard-working Australian families and businesses have to pay disproportionately high taxesbecause multinational corporations are not pulling their weight.
Australian Government Initiatives
Faced with the choice of abandoning the corporate tax base or protecting it, the Gillard Government chooses to protect it.
We will continue to take action where necessary to ensure the integrity and sustainability of the tax system, including our corporate income tax base.
And we are doing this by reforms to two of the key integrity regimes in our tax laws- our transfer pricing rules and the general anti-avoidance rule known as Part IVA.
Australia's transfer pricing rules play an important role to ensure that multinational firms pay their fair share of tax on profits in Australia - based on an amount of income which reflects the economic activity attributable to Australia.
As I'm sure you know, in November 2011, the Government announced its review of Australia's transfer pricing laws.
The review has been aimed at more closely aligning our rules with international best practice as set out by the OECD.
Our first task was to ensure that the law continued to operate in a manner consistent with the Parliament's long-held understanding and widely disseminated ATO guidance material that treaty transfer pricing rules apply to provide assessment authority in treaty cases.
These amendments received Royal Assent on 8 September 2012.
I know that there are strong held views about those changes- and that applying the amendments back to 2004 was controversial.
The Government makes no apologies for protecting the significant revenue that would have been at risk from taxpayers seeking to exploit uncertainties about Australia's revenue base.
We are now turning our attention to a wholesale modernisation of Australia's transfer pricing regime, which will align our laws with the most recent benchmarks of international best practice as set out by the OECD.
Today, I am releasing for consultation an exposure draft containing the amendments necessary to modernise our domestic transfer pricing laws.
Previous discussions with stakeholders have indicated that there is general support to reform our transfer pricing rules making them more effective and relevant to the modern environment in which multinationals operate.
I encourage industry and the wider community to engage with Treasury on these important reforms.
General Anti-Avoidance Rules
Last week, I also released for public comment exposure draft legislation and explanatory material to protect the integrity of Australia's tax system by amending Part IVA of the income tax laws.
The amendments will ensure that Part IVA can apply to taxpayers who enter into arrangements with the sole or dominant purpose of avoiding tax.
The amendments focus on the definition of 'tax benefit'. They will not affect taxpayers unless they have obtained a tax advantage from an arrangement entered into with a relevant tax avoidance purpose.
For example, the amendments could play a role in countering multi-nationals who seek to defeat Australia's taxing rights by artificially altering the source or character of profits they generate from economic activity in Australia.
The amendments will ensure that such enterprises are taxed on the reality of their Australian activities- they will not be able to argue they did not get a tax benefit simply because they would not have invested in Australia had they known, in advance, that they would have to pay tax here.
I encourage you to participate in the consultation process.
We need to make sure that we are doing everything possible through our domestic laws to keep up with the changing nature of global commerce in the information age.
More importantly, Governments all around the world need to rethink many of the key rules of international taxation, which are not keeping up with the changing business models and tax planning arrangements of many multinational companies.
Rethinking key aspects of the international tax architecture, by definition, requires international cooperation, as difficult as that may seem.
While I understand the degree of difficulty involved, we should also recognise that the G20 and the Global Financial Crisis have changed the dynamics of international relationships.
G 20 & Global Forum on Transparency and Exchange of Information for Tax Purposes
The OECD Global Forum on Transparency and Exchange of Information for Tax Purposes (Global Forum) was established in the early 2000s as a vehicle for OECD economies to promote greater transparency- particularly with regard to access to information held in secrecy jurisdictions and tax havens.
This followed work by the OECD on harmful tax practices that focussed on "unfair" competition by low or no tax jurisdictions, as well as the exploitation of bank secrecy and lack of international co‑operation to hide tax avoidance or evasion activity.
The idea is that effective international co-operation and information sharing can help to tackle tax avoidance and evasion.
In turn, this improves the integrity and sustainability of the tax base of all countries.
The April 2009 G20 Leaders' meeting in London put the work of the Global Forum firmly on its agenda, stating that:
"We agree to take action against non-cooperative jurisdictions including tax havens. We stand ready to deploy sanctions to protect our public finances and financial system. The era of bank secrecy is over."
This crystallised the implementation of commitments and encouraged all members to translate these into action.
Critically, all major financial centres have become deeply engaged in this process.
The Global Forum has made significant progress in ensuring international cooperation in the exchange of information.
The work of the Global Forum is changing international practice as member countries and jurisdictions respond to the recommendations of peer review reports.
More than 800 agreements that provide for the exchange of information in tax matters have been signed by various jurisdictions.
Australia has signed 30 of our 33 Tax Information Exchange Agreements with low tax jurisdictions in the last 5 years.
Through our membership of the G20, the OECD, and particularly, as Chair of the Global Forum for the past three and a half years, Australia has been at the forefront of the development and implementation of the international standard for exchange of information.
While Australia will shortly pass on the role of Chair of the Global Forum to South Africa, we will continue to be actively engaged in the work of the Global Forum.
G20 & OECD work on Base Erosion and Profit Shifting
These international efforts are not just about increasing transparency.
The G20 has also been arguing for the need for greater international co-operation to prevent base erosion and profit shifting. This has also enabled the OECD to give priority to this issue.
The international tax treaties system has served us well in preventing double taxation, and therefore promoting cross border trade and investment.
There is an increasing recognition that rules designed to prevent double taxation have in some cases resulted in double non-taxation instead - where income is not taxed in any jurisdiction.
This situation is unsustainable - it not only weakens the tax base of individual countries but also weakens the international tax system.
As the Chair of the OECD's Committee of Fiscal Affairs, Mr Masatsugu Asakawa has said:
"International tax policies must therefore be adjusted to the current business environment, in a way that ensures a level playing field and a fair allocation of taxing rights among both developed and developing countries."[viii]
As you would expect, Australia is actively involved in the OECD's work to address the important challenges of intangibles and hybrid mismatch arrangements.
Although there is a long way to go, it is clear momentum to address these issues is building and that the focus of multilateral attention is now squarely on addressing situations of "double non-taxation".
What else could be done?
As important as these initiatives are, the reality is that countries around the world with corporate income tax systems will continue to be challenged by those who seek to shift income to low or no tax jurisdictions.
Greater Transparency on Tax Paid
One response to criticisms of low corporate effective tax rates is to criticise the basis on which the calculations are made.
It is true that these calculations often require a number of simplifying assumptions - and there are many traps for the unwary in comparing tax and accounting data.
It is also true that reports comparing income tax paid with gross sales revenue are to some extent comparing apples with oranges.
But if these criticisms are valid, I would have thought that the better response would be for companies operating in Australia to be more upfront on the revenue they derived from sales in Australia and the income tax contribution they make to the Australian community.
Exploring the problem further
To deepen our understanding of these issues, I have also asked Treasury to develop a scoping paper, to be led by the head of Revenue Group, Rob Heferen.
The discussion paper will set out the risks to the sustainability of Australia's corporate tax base and look at the potential solutions.
The Treasury analysis will be informed by a specialist reference group, made up of representatives from business, tax professionals, academics and the community sector.
This follows the Government's efforts since it came to office to increase consultation and the involvement of the community in the tax design process.
I would like to conclude on a positive note.
Despite the challenges facing Australia's corporate tax system that I have outlined today, it remains the case that $66.6 billion in company income tax was paid in 2011‑12.
So our company tax system is far from broken.
My message today is simply that there are some looming threats to the corporate tax base and that we would be negligent not to consider them and work towards developing effective and appropriate responses.
The Gillard Government is committed to a fair, competitive and sustainable corporate tax base.
The Government is taking action to improve the integrity of Australia's income tax laws, through modernising our domestic transfer pricing regime and ensuring Part IVA works as intended.
Australia is also actively engaged in multilateral efforts to improve international cooperation on tax issues and address fundamental problems in the international tax architecture.
And the Government continues to engage with the Australian community on how to get the balance right in addressing these issues.
[ii] David Ramli, "Google Australia Tax Bill Slashed by 90pc", The Australian Financial Review, 3 May 2012; other reports estimate the figure to be as high as $2 billion. See for example, Ben Butler and Georgia Wilkins, "How Savvy Multinationals Curb Their Tax Bills", Sydney Morning Herald, 17 November 2012.
[iii] See for example, Jessie Drucker, "Google's Recipe forTax-Rate Cut: Double Irish and a Dutch Sandwich", The Washington Post, 31 October 2010, Mike Seccombe, "Google: Don't Be Evil, Don't Pay Tax", The Global Mail, 7 June 2012.
[iv] Of course, any income earned by Google Australia for services provided to the Irish subsidiary would still be taxable here, and would be subject to transfer pricing rules.
[vii] Rajeev Syal, "Amazon, Google, Starbucks Accused of Diverting UK Profits", The Guardian, 12 November 2012.