This article was first published by Bloomberg Tax, May 2024.

The 2024-2025 Australian federal budget released this month continues to balance inflationary pressures with cost-of-living concerns. In this environment, specific measures on royalty tax avoidance and foreign resident capital gains tax target multinationals and foreign investors in Australia.

The tax provisions portend more litigation risk for foreign investors and higher compliance costs for multinationals. Multinationals that receive payment for the use of intangible assets in Australia, and foreign residents who invest in Australian land, should take reasonable care in assessing their tax positions at the transaction’s outset.

Royalty Tax Penalty

Significant global entities, or SGEs, with over AU$1 billion ($661 million) in global annual turnover would face new penalties for avoiding royalty withholding tax by mischaracterizing the nature of the payment or undervaluing royalty amounts starting July 1, 2026.

The new penalty would be imposed based on the level of taxpayer culpability—25% for failure to undertake reasonable care or 75% for intentional disregard of the law. The penalty would double for SGEs. (Further details of the new penalty haven’t been released.)

SGEs that use intellectual property in Australia and pay royalties to non-Australian entities would need to accurately calculate the amount of royalty withholding tax, as any incorrect calculation may result in significant penalties.

There may be increased litigation similar to the PepsiCo Inc. case for “embedded royalties,” where payment for goods or services includes a component for the payment of the Pepsi brand. Given the complexity of such arrangements and valuation of intangible assets, disagreement likely would arise on the exact nature of the royalty payments, apportionment of payment, and the correct amount of royalty withholding tax.

SGEs should review their current agreements to identify potential risks and make necessary amendments, particularly those regarding services supplied and payment clauses. Because these contracts are usually long-term and involve global entities, consideration and amendments should be made well before July 1, 2026, to avoid penalties.

Finally, SGEs should consider how the new penalty rules would interact with transfer pricing provisions, diverted profits tax, the 15% global minimum tax, and general anti-avoidance rules—which likely would be in force by the penalty’s effective date.

Foreign Resident CGT

The government late last year announced that starting Jan. 1, 2025, the foreign resident capital gains tax withholding rate would increase to 15%, and the purchase price threshold of AU$750,000 would be removed.This announcement foreshadows the 2024-2025 budget proposal to ensures better compliance by foreign residents with their Australian tax obligations.

The proposal further amends the foreign resident capital gains tax to apply to all assets with “a close economic connection to Australian land,” tested over a one-year period starting July 1, 2025. Foreign residents selling shares or membership interest in a company exceeding AU$20 million must notify the Australian Taxation Office prior to the transaction’s execution.

Foreign investors must beware broad application of this rule. The measure is expected to raise AU$600 million over five years from 2023-24, suggesting the government’s intention to significantly broaden the tax base to capture assets with any relation to “Australian land.” Examples may include mining licenses and renewable energy assets.

Foreigners investing in Australia would face increased compliance and regulatory costs. The extension of the testing period means a company may need to undertake asset valuations and perform an averaging exercise over a one-year period. This change also would prevent staggered sell-offs of property within a year to avoid capital gains tax withholding rules.

The notification requirement continues the ATO’s trend of ensuring disclosure and transparency. It allows the ATO to identify potential risks to the Australian tax base and take pre-emptive actions.

It’s not yet clear whether this is a true “notification” to the ATO or whether ATO “approval” would be required prior to commencement of the transaction—similar to the Foreign Investment Review Board approval process. Similarly, the FIRB is more willing to impose a requirements for taxpayers to notify the ATO before disposing of assets as a FIRB condition, further highlighting the ATO’s proactive regulatory approach.

Outlook

These measures increase compliance costs for foreign investors engaged in merger and acquisition transactions and litigation risks concerning the nature and characterization of royalty payments for SGEs.

SGEs and foreign investors likely to be affected by these rules should carefully consider the specific details once the enacting legislation is passed. Businesses should try to understand the tax implications, consult tax advisers at the outset of transactions, and meticulously plan and draft transaction documents. It may also be worthwhile to engage with the ATO early to discuss these issues.

This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2024.

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