Treasurer Scott Morrison delivered the 2016 Federal Budget last night with a list of measures designed to boost "jobs and growth". But what does this all mean for intellectual property in Australia?
Here are the big five for IP:
- The introduction of a Diverted Profits Tax is among a suite of measures designed to ensure multinational companies pay their “fair share” of tax, including new powers and significant funding for enforcement.
- The Budget and papers released in the lead up to the Budget deal specifically with some very technical issues associated with intangibles and intellectual property, particularly with respect to multinational enterprises (MNEs) using these for the purposes of avoiding or reducing taxation paid in Australia. Top multinational companies also need to consider the impact of Australia’s adoption of the OECD’s comprehensive guidance on transfer pricing practices associated with intellectual property and hard to value intangibles.
- Despite early indicators that the Government was considering the introduction of a ‘Patent Box’ style tax incentive as part of its ‘ideas boom’ agenda, there was no mention of the incentive in this year’s budget. Instead the government focused on long term reductions to the corporate tax rate, with an initial focus on relieving SMEs.
- Good news for small businesses. The reduction in the corporate tax rate results in an increased R&D tax benefit of 17.5% to small businesses with less than $10 million turnover. There are also significant cashflow benefits available to companies who are able to bring forward any capital asset purchases for R&D purposes.
- With the growth of Australia’s export economy a focus of Treasurer Morrison’s budget preamble, we thought the Export Market Development might feature. However despite this sentiment, the Treasurer made no explicit reference to the EMDG. We suspect that ‘no news is good news’. As a result, we anticipate that the Turnbull Government will honour last year’s budget pledge to increase funding to the EMDG program by $50 million across four years, good news for EMDG applicants.
Cracking down on multinational tax avoidance
The crackdown on tax avoidance by multinationals has dominated headlines recently. It’s clearly high on the Government’s agenda, given the measures announced in Treasurer Morrison’s first budget.
The ATO has been endowed with more power and resources than ever before. Exactly how the ATO yields these powers remains to be seen. What is certain is that transfer pricing will continue to dominate headlines.
The new provisions released in this year’s budget to address tax avoidance by multinational enterprises seek to build on recent changes to transfer pricing legislation. The government’s intention is to further strengthen Australia’s anti-avoidance tax laws and the ATO’s powers. In doing so, the Government ultimately aims to raise at least $3.7bn in revenue over the next four years.
Measures introduced to date
Multinational profit shifting is clearly a hot topic in the run-up to the election. However, given the suite of legislative changes the Government has introduced to date, it is hard to imagine what reasonable legislative measures remain available for election campaigning.
In the last 3 years, the Government has:
- Introduced new transfer pricing legislation (s815 of the ITAA 1997)
- Adopted the OECD’s country-by-country reporting requirements for large multinationals
- Given the Foreign Investment Review Board the power to force foreign investors to negotiate with the ATO regarding the terms of any international related party dealings
- Started the ATO’s International Structuring and Profit Shifting compliance initiative
- Held a Senate enquiry in to multinational tax avoidance
- Provided the ATO with $86 million in extra funding to crack down on multinational profit shifting, including the funding of a six-year investigation in to Chevron (which ended in a federal court case won by the Commissioner of Taxation but currently being appealed by Chevron)
- Introduced the Multinational Anti-Avoidance Law (MAAL) in last year’s budget
What’s new in the Budget?
This year’s budget built on the recently introduced MAAL legislation through the introduction of a Diverted Profits Tax. The proposed diverted profits tax is a stand-alone “Google tax”, similar to the UK’s diverted profits tax. Whilst MAAL is essentially a “bolt-on” to Australia’s general anti-avoidance provisions under Part IVA, the Diverted Profits Tax will work alongside MAAL by imposing a new tax at 40% for large multinationals with structures and activities undertaken principally to avoid Australian tax.
The implementation of the MAAL legislation is already the subject of a number of multinational entities entering into arrangements that the ATO views as “artificial and contrived”. To address the issue, last week the ATO released four taxpayer alerts focusing on multinational tax avoidance in respect of a number of particular transactions. Taxpayer alert TA 2016/2 specifically addressed arrangements undertaken to avoid MAAL whereby members of multinational groups contractually swap roles, thereby avoiding the application of MAAL. The ATO stated clearly that audits would take place to review such arrangements, imposing penalties of up to 120% of the tax avoided.
In a final step to ensure the Government is able to address wide spread tax avoidance by multinationals, the Government announced a new ATO Tax Avoidance Taskforce. Supported by additional funding to the ATO of $679m, the taskforce will have 1,000 people pursuing tax avoidance by both multinationals and high tax individuals.
The technicalities – how will intangibles and IP be regarded by the ATO
The Budget and papers released in the lead up to the Budget deal specifically with some very technical issues associated with intangibles and intellectual property, particularly with the respect to multinational enterprises (MNEs) using these for the purposes of avoiding or reducing taxation paid in Australia.
Revaluation of internally generated intangible assets for thin capitalisation purposes
Despite a number of media reports suggesting the thin capitalisation debt deduction would be reduced to 50%, the Budget was silent on the issue. With that said, last week the ATO issues a suite of Tax payer Alerts, one of which specifically targeted the revaluation of internally generated intangibles for thin capitalisation purposes (TA 2016/1).
Under Australia’s accounting standards (AASB 138 – Intangible Assets), internally generated intangibles are not recognised as an asset for balance sheet purposes. However, section 820-683(2) of the Income Tax Assessment Act 1997 allows entities to make a choice to recognise internally generated intangibles for the purposes of a thin capitalisation calculation.
In TA 2016/1, the ATO indicates that it is concerned that multinational companies may be inappropriately recognised as assets, with the consequence of increasing an entity’s maximum allowable debt limit under the thin capitalisation rules. Of particular concern is the inclusion of internally generated intangibles within thin capitalisation calculations, that do not meet the definition under AASB 138. Examples cited by the ATO as inappropriately recognised internally generated intangibles include:
- Market related items, such as customer relationships or loyalty
- Human resource items, such as ‘skilled staff’, ‘management’ or ‘key employees’
- Organisational resources, including ‘internal policies’, ‘procedures’ or ‘manuals’
The ATO also provide examples whereby internally generated intangibles have been values by applying unsupportable or questionable management assumptions or using growth rates that are in excess of historic or probable market indicators.
It is clear that the Government is serious about restoring the integrity of the Australian economy, by cracking down on tax avoidance by multinational companies. But it is equally clear from the information contained in the ATO’s recently released Taxpayer Alerts that multinational companies and their advisors are actively investigating opportunities to circumvent Australia’s tough new transfer pricing measures. While the Commissioner has an array of powers available to enforce Australia’s transfer pricing and related multinational tax avoidance provisions, according to TA2016/1, the Commissioner is also considering the extent of his powers in instances where companies over value internally generated intangibles, in order to reduce its tax liability within Australia.
Australia to adopt the OECD’s Transfer Pricing recommendations – so what does it all mean for IP?
Top multinational companies will be today considering the impact of Australia’s adoption of the OECD’s comprehensive guidance on transfer pricing practices associated with intellectual property and hard to value intangibles.
This year’s budget included an announcement that Australia’s transfer pricing laws will be amended from 1 July 2016, in order to implement the OECD’s transfer pricing guidelines and recommendations. It’s particularly relevant for top companies who own or are developing intangibles and intellectual property that could be used within a multinational group. This will include the adoption of the revised version of Chapter VI of the OECD’s Transfer Pricing Guidelines, which includes guidance on:
- Identifying intangibles
- Ownership of intangibles and transactions involving the development, enhancement, maintenance, protection and exploitation of intangibles
- Transactions involving the use of intangibles
- Supplemental guidance for determining arm’s length conditions in cases involving intangibles.
For the first time, the 2015 OECD Guidance defines an intangible asset for transfer pricing purposes as something ‘which is not a physical or financial asset, which is capable of being owned or controlled for use in commercial activities and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances’. The 2015 Guidelines also provide some examples of types of intangibles that fall within the definition, including both intellectual property, such as patents and trademarks, that can be registered, but also other assets such as knowhow, trade secrets and contractual rights.
With Australia adopting this broad definition within the OECD guidelines, time will tell how the ATO enforces the application of the arm’s length principle for the use of assets that are extremely hard to identify and even harder to value. Watch this space.
Lowering corporate tax rate - the strategy to drive investment
To foster an Australian business environment that nurtures and retains entrepreneurial talent, the Turnbull Government has expanded on measures introduced in last year’s Budget, to introduce further reductions in the corporate tax rate. Specifically, from 1 July 2016:
- Companies with a turnover of less than $2 million will see a 1% reduction in their tax rate (from 28.5% to 27.5%).
- Companies with a turnover of more than $2 million but less than $10 million will see a 2.5% reduction in their tax rate (from 30% to 27.5%).
- Companies with a turnover of more than $10 million will see no immediate change in their tax rate.
Businesses with a turnover between $2 million and $10 million are the immediate beneficiaries of this measure. However, with the announcement of an aspirational tax rate of 25% to be achieved for all businesses through staged reductions over ten years, there’s light at the end of the tunnel for large companies as well.
Tax rate is one of many factors that can drive investment in business and innovation. But, given Australia’s tight economic environment this level of corporate tax rate could play a significant role in driving growth and investment within Australia. While it’s difficult to imagine being able to compete with our neighbours on the cost of labour, changes to the tax and regulatory environment could assist Australia to better capitalise its investment in research, by ensuring our research outcomes remain within Australia, for the benefit of the Australian economy.
The Government’s ten year plan for reducing the overall corporate tax rate to 25% would help drive investment in Australia. But the question remains as to whether we can expect any individual Government to see a ten year plan through to completion, particularly given the revenue measures required to fund it. So while it’s a step in the right direction, the corporate income tax rates of OECD nations such as the United Kingdom (20%) still paint a more competitive picture than the aspirational Australian corporate tax rate of 25%, proposed in this year’s budget.
What happened to Patent Box?
Despite early indicators that the Government was considering the introduction of a ‘Patent Box’ style tax incentive as part of its ‘ideas boom’ agenda, there was no mention of the incentive in this year’s budget. Patent box programs like those used in the UK, Italy, Spain, The Netherlands and France, are an alternative option for focussing tax incentives on innovative businesses. These regimes use discounted tax rates on profits derived from registered IP to focus tax incentives on businesses that create high value jobs. Nations that implement these programs continue to report their success, with businesses like GlaxoSmithKline relocating offshore R&D operations back to the UK to take advantage of the regime. Other businesses are citing patent box benefits in financial reports, demonstrating strong adoption of the incentives.
A patent box program is something that should be given serious consideration to help Australia nurture and retain high value businesses.
The R&D Tax Incentive – What’s New?
A centrepiece of this year’s Budget was the announcement of a Ten Year Enterprise Tax Plan,which will initially provide a 2.5% reduction in the corporate tax rate for small businesses with a turnover of less than $10million a year, effective 1 July 2016. The measure proposes that the turnover threshold to access this reduced tax rate will be raised incrementally until 2023-24, before the corporate tax rate is reduced to 25% for all businesses at the end of 2026-27. This reduction in tax rate raises the potential for the Government to revisit previous plans to implement a corresponding reduction in the R&D Tax Incentive rate.
Currently, companies with an aggregated turnover of less than $20 million can access a 45% refundable R&D tax offset if in losses, with a minimum 15% permanent tax benefit for companies in a tax paying position. Previous proposals to reduce the corporate tax rate have been coupled with corresponding proposals to reduce the R&D tax offset rates for all companies.
While the previous announcement of proposed R&D tax offset rate cuts caused uncertainty for companies looking to access the R&D Tax Incentive, the Bill to implement these measures stalled in Parliament and recently lapsed before the Senate. Consequently, the proposed measures to reduce the R&D tax benefit to match the reduction in corporate tax rates won’t proceed.
This year’s Budget papers on the recently announced reduction in corporate tax rate for small businesses do not clarify the Government’s intentions regarding the impact of this change on existing R&D Tax Incentive rates. Based on past history, the Government could again seek to introduce legislation to reduce the refundable R&D tax offset to 42.5% to ensure the permanent tax benefit for small businesses accessing the R&D Tax Incentive remains at 15%. As such, companies should stay mindful of similar legislation being introduced in the future. However, until further announcement, the good news is that the reduction in corporate tax rate results in an increased R&D tax benefit of 17.5% to small businesses with less than $10 million turnover.
Other good news for SME’s
There is a significant opportunity for small business to take advantage of potential cashflow benefits associated with the immediate deductions for asset purchases of up to $20,000. The Budget announced the extension of this policy, effective to 30 June 2017 with an increase of the turnover threshold from $2 million to $10 million to match the corporate tax relief. The opportunity exists for companies seeking to purchase R&D specific assets to incorporate the write-off as part of its 45% refundable R&D tax offset. This would provide a significant cashflow benefit if companies are able to bring forward any capital asset purchases for R&D purposes.
Continued support for Australian Exporters
With the growth of Australia’s export economy a focus of Treasurer Morrison’s budget preamble, we thought the Export Market Development Grant might feature. However despite this sentiment, the Treasurer made no explicit reference to the EMDG. We suspect that ‘no news is good news’, and so we expect that the Turnbull Government will honour last year’s budget pledge to increase funding to the EMDG program by $50 million across four years.
While funding for Australia’s premier export incentive appears to remain steady, there have been a number of changes made to the EMDG program in the lead up to the budget announcement which will impact businesses seeking to commercialise their IP in overseas markets. The most recent changes announced pre-budget focused on better aligning EMDG demand with the EMDG budget, with some of the recent changes likely to result in a reduction in the average EMDG claim size from the 2017 grant period onward. These changes include:
- An increase to the daily overseas travel allowance from $300 to $350 per person per day, in order to offset the fact that Austrade will disallow a variety of overseas travel expenses, including ground transportation (transfers/taxis/etc), visas, travel insurance, etc;
- The removal of the Communications expense category, to reflect the decreased cost of global communications due to advancing technology; and
- Capping the Free Samples expense category at $15,000 (previously there was no cap).
In addition to these recently announced changes to the EMDG program, the Government also provided some assurance that the program will continue, including:
- The removal of the sunset provisions, which eliminate the requirement of the Government to ‘renew’ the program every 5 years; and
- Permitting Austrade to direct funds from other sources (i.e. other programs) towards the administration of the EMDG program. Historically Austrade could only fund the administration of the program from funds allocated to the EMDG budget, meaning administration reduced the funds available to EMDG applicants.
While these changes are likely to result in increased EMDG claims for SME businesses seeking to export their goods and services to the world, the Government’s focus on the development of export growth, coupled with the fact that the EMDG program continues to receive strong bipartisan support, provides confidence that the EMDG program is likely to continue into the foreseeable future.