In this edition: status of the 385 debt regulations in limbo and Australia takes unilateral action by enacting diverted profits tax.
Status of the 385 Debt Equity Regulations in Limbo
Following Donald Trump's victory in the November election, the fate of the recently finalized 385 Regulations has been caught in a state of limbo. Complicating matters, the debate on the 385 Regulations has taken a back seat to broader tax reform and other legislative initiatives developing in the new Congress. As background, the 385 Regulations, finalized on October 13, 2016 under the previous Administration, provide for a strict framework for what qualifies as debt in an intercompany context and also provides for minimum documentation standards for the debt characterization of an issuance.
On the surface, the 385 Regulations appear to be in jeopardy as the Congress and the new Administration favor steps to deregulate the economy. Since being sworn in, the 115th Congress has used the Congressional Review Act ("CRA") to remove several existing Obama era regulations. Further, Congressman Todd Rokita (R-IN) has already introduced a resolution in the House, H.J.Res.54, to repeal the 385 Regulations by invoking the CRA. Separately, the President has signed an Executive Order requiring that for any new regulation being proposed, at least two existing regulations be identified for elimination.
Despite this climate of deregulation, speaking at the International Fiscal Association’s ("IFA") 45th Annual U.S. Conference, Marjorie Rollinson, Associate Chief Counsel International at the Internal Revenue Service ("IRS"), offered an altogether different take suggesting that the 385 Regulations are exactly in line with President Trump’s broader "America First" agenda. Specifically, she argued that the 385 Regulations were designed to limit corporate inversions whereby corporations merge with a foreign corporation to ultimately lower their tax bill.
In light of these comments, the 385 Regulations appear to be caught between broader tax reform discussions, a deregulation friendly environment, and an Administration with an "America First" agenda.
Going forward, there are four areas that interested parties should keep an eye on:
- The incoming Treasury Secretary Mnuchin, who can repeal these rules;
- President Trump, who can repeal these regulations through Executive Order;
- Advancement of H.J.Res.54 which invokes the CRA to repeal the regulations; and
- Broader tax reform which could render these rules moot if changes to the tax code ultimately include eliminating the deductibility of interest entirely.
Transfer Pricing Times will keep readers apprised of changes to these regulations as they occur. In the meantime, many taxpayers are proactively preparing to comply with these regulations (effective for relevant instruments issued on or after January 1, 2018). Our financial services transfer pricing team presented on best practices and 385 documentation strategies at both IFA and TP Minds last week.
Further information is available here.
Australia Takes Unilateral Action by Enacting Diverted Profits Tax
On February 9, 2017, the Australian Government introduced the Treasury Laws Amendment (Combating Multinational Tax Avoidance) Bill 2017 into Parliament, the key aspects of which will be inserted into Part IVA [the Australian tax avoidance provisions] of the Income Tax Assessment Act 1997 ("ITAA 1997").
The Bill will implement:
- A Diverted Profits Tax ("DPT") for Significant Global Entities1 ("SGEs"), to ensure that Australian tax payable reflects the economic substance of the SGE’s Australian operations;
- Increased penalties for non-compliance, where "Failure to Lodge" can be AUD 525,000; and
- Formal adoption of OECD BEPS Actions 8-10 into Australian transfer pricing law.
This discussion focuses on the DPT legislation, which reflects a more unilateral response to OECD BEPS Actions. The DPT applies to income years commencing on or after July 1, 2017 and will impose a 40% 'penalty tax', payable on the diverted profits (c.f. 27.5% corporate tax rate in Australia). The DPT applies if the taxpayer obtains a tax benefit in connection with an arrangement involving a foreign associated party, and the relevant arrangement was carried out for a principal purpose of enabling the taxpayer(s) to obtain a tax benefit, or obtain a tax benefit and reduce a foreign tax liability. The principle purpose assessment takes into account various factors of the arrangement, including form, substance and financial impact on the parties involved, non-tax financial benefits, etc.
The DPT will not apply if any of the following tests apply:
- The summed Australian turnover of the Australian operations does not exceed AUD 25 million2;
- The increase in foreign tax liabilities of foreign entities is 80% or more of the reduction in Australian tax liability3; or
- The profits derived by each entity involved in the arrangement reasonably reflects the economic substance of activities undertaken in connection with the arrangement4.
The economic substance test considers the functions performed, assets used and risks assumed, and the profits derived, as determined based primarily on OECD Guidelines. Hence, Australian taxpayers transacting with an associated party/ies that has/have low functional profiles, but high profit may be targeted, particularly those arrangements involving tax holidays, tax havens, etc.
Further information on Australia's DPT legislation is available here.
1An entity with annual global income of AUD 1 billion or more, or part of a global group with annual income of AUD 1 billion or more.