31% of companies are not paying tax in Australia. How do they do it?

Large companies paid the Australian government a record A$100 billion in tax in the last year, a 17% increase on the previous year. But, over the same period, there were still 31% of large companies, operating here but not paying any tax.

The Australian Taxation Office’s annual corporate tax transparency report^[1] released last week includes data on nearly 4,000 of Australia’s largest corporations.

In its tenth year, the report is lauded by the government^[2] and ATO as a way to increase corporate accountability and reduce tax avoidance. But there is no detail on the tax practices of multinational entities, including how they interact with their offices around the world.

In particular, there is little information about how 1,200 companies paid no tax.

What the report tells us

The transparency report provides data on corporations with income of $100 million or more and businesses which pay the petroleum resource rent tax ^[3](PRRT). This includes Australian public and foreign-owned corporate tax entities, as well as Australian-owned resident private companies.

The report details the total income, taxable income, tax payable, and PRRT payable for all entities that meet the reporting threshold. Taxable income is simply assessable income minus deductions. Tax payable as a percentage of taxable income, can then be used to calculate an effective tax rate. The statutory corporate tax rate is 30%.

A variation between an effective tax rate^[4] and the statutory tax rate ^[5] is not evidence of tax avoidance. However, questions need to be asked about how profitable companies reduce their tax liability to zero.

Zero liability can be achieved by deducting offsets and credits. For example, companies that conduct significant research and development are given tax breaks which reduce the amount of tax payable.

Where a company has accounting losses or a tax loss because it has incurred more expenses than income, tax will be zero. These are legitimate reasons for paying no tax.

But the limited information provided simply tells us how profitable a company is, the amount of tax deductions claimed against that profit, and the tax payable.

What the report doesn’t tell us

The transparency report reveals little about tax practices of multinational entities.

The question remains what deductions are being claimed by corporations and tax entities. The ATO has this information but can only publish what the law allows them, which is limited.

For multinationals, deductions will include dealings with overseas parts of the global entity, such as subsidiaries or the parent entity. These transactions create legitimate tax deductions.

Common transactions include payments to overseas subsidiaries for services^[6], royalty payments for intellectual property, and interest on overseas borrowings.

In the case of petrol company Chevron^[7], money was borrowed in the United States at around 1.2% and on lent to a related Australian entity at 9%.

After a long court battle, about 5% of interest was allowed as a deduction, an amount significantly above the original interest rate. This gave Chevron in Australia a large tax deduction.

It is through these types of transactions profits earned in Australia are shifted overseas. Current tax law allows this but requires the transaction, known as the transfer price^[8], to be at arm’s length^[9] - that is, the price is agreed to between independent parties entering the same transaction.

What is transfer pricing?

Multinationals are global by nature and therefore logically maximise worldwide profits. Tax systems do not operate in the same way.

Tax comes under domestic law which means transactions between parts of a global entity are recognised for tax purposes.

If goods or services are sold by one part of the entity to another, an internal transaction occurs. For tax purposes the transaction is recognised as a deduction in one location and income in another. An Australian entity would pay a foreign party for things like marketing, and get a deduction for the expense.

In recent years the ATO has settled^[10] marketing disputes with large multinationals including Google, BHP, Apple, Rio Tinto, ResMed and Microsoft.

Where a deduction is allowed in a high tax jurisdiction, such as Australia, and income is included in the profits of a low tax jurisdiction, such as Singapore, the result is larger overall global profits.

The tax system recognises the incentive for multinational entities to shift profits this way and requires transactions to be at a commercial or negotiated price. Determining the price however can be fraught and has led to numerous court cases^[11] and tax disputes.

The tax transparency report reveals nothing about these types of transactions.

Taxing multinationals in Australia

In the last decade there have been moves to tax income in the location of the economic activity. The OECD^[12] has tried to stop profit shifting by companies, which erodes the tax base of high taxing jurisdictions, through its tax reform agenda.

Further complicating the issue of transfer pricing is the question of whether there is any real activity in the countries where different parts of a multinational are located.

Singapore is recognised for what are known as service hubs. These are places where various services such as sales negotiations are conducted and marketing occurs. Singapore also happens to have a headline corporate tax rate of 17%. This is often reduced to single digits after deals are entered into between taxpayers and the Singapore revenue authority.

Intellectual property^[13] poses similar problems.

These are increasingly valuable assets for multinational entities as they provide a unique edge in the market. We only need to think of Apple, Microsoft and Google to understand how valuable names, logos and designs are.

By its very nature intellectual property has no physical location and can be owned anywhere in the world. Often, intellectual property is held in low or no tax countries.

The transparency report includes no details about how much is transferred to these locations. This is where Australia’s proposed^[14] public country-by-country reporting may assist.

Is the ATO’s corporate tax transparency report worthwhile?

Australia should continue to strive to be a leader in corporate tax transparency.

A two-step approach is required to eliminate corporate tax avoidance. Information is valuable and public transparency measures are an important first step.

A second step, however, is to reform substantive tax laws to tax profits where they are genuinely being generated.

References

1. ^{^} corporate tax transparency report (www.ato.gov.au)
2. ^{^} government (ministers.treasury.gov.au)
3. ^{^} petroleum resource rent tax (australiainstitute.org.au)
4. ^{^} effective tax rate (www.investopedia.com)
5. ^{^} statutory tax rate (www.oecd-ilibrary.org)
6. ^{^} services (theconversation.com)
7. ^{^} Chevron (www.taxand.com)
8. ^{^} transfer price (www.investopedia.com)
9. ^{^} arm’s length (www.royaltyrange.com)
10. ^{^} settled (www.ato.gov.au)
11. ^{^} numerous court cases (www.accountingtimes.com.au)
12. ^{^} OECD (www.oecd.org)
13. ^{^} Intellectual property (business.gov.au)
14. ^{^} proposed (treasury.gov.au)