Chapter 5


Chapter 5

Submitters' views on Parliament's intention

5.1        The Explanatory Memorandum (EM) stated that proposed Subdivision 815-A will apply on or after 1 July 2004 as 'the 2004 income year commenced immediately after the Parliament's most recent amendment to the income tax laws in 2003'.[1] The EM sets out in some detail 'evidence that Parliament understood the law to operate consistently' with the amendments set out in the bill:[2]

Given the consistent assumption by Parliament since at least 1982 that treaties provided a separate basis for making transfer pricing adjustments, the proposed amendments could apply from the commencement of Division 13 and the accompanying changes to section 170 and former section 226 of the ITAA 1936.

Subdivision 815-A, however, will only apply to income years commencing on or after 1 July 2004. The 2004 income year commenced immediately after the Parliament's most recent amendment to the income tax laws in 2003 which again evidenced the Parliament's understanding that tax treaties could be used as a separate basis for making transfer pricing adjustments.[3]

5.2        In the context of questioning Parliament's intention on the matter, the majority of submitters involved in this inquiry strongly opposed the retrospective nature of the bill. The Institute of Chartered Accountants in Australia commented for example:

A signal of the importance of freedom from retrospective laws has been held to be so critical to the basic rights of individuals and corporations that the constitutions of both the United States and Sweden have explicitly prohibited such a practice. Whilst Australia's constitution does not expressly prohibit the making of retrospective laws, the generally accepted practice of parliament has been to only exercise those powers sparingly, often only in extreme and exceptional circumstances.[4]

5.3        An article provided by PricewaterhouseCoopers (PwC), in support of their view, further highlighted concerns around the use of retrospective legislation:

Retrospective legislation has been labelled as "...unjust, undemocratic, unreliable and contrary to human rights, individual autonomy, the rule of law and the Constitution". Some even claim that it is not law at all.[5]

5.4        Submitters suggested that the bill proposes amendments that are not a 'mere clarification', as reported in the EM, but amount to a retrospective change to the law. For example, the Corporate Tax Association of Australia (CTAA) stated:

It is most disappointing that our objections (and those of other parties) have been met with not much more than the repeated assertion that the proposed new law merely 'clarifies' what was always the intention of the Parliament. Other than comments from senior ATO officials (who administer but don't make the law) there is scant evidence of any such intention. And even if there were, the court decisions referred to in our earlier submission suggest that any such intention was never in fact achieved. Taxpayers are entitled to rely on the law as it has been consistently interpreted by the courts over many years, and retrospective changes like this can only erode business confidence in Australia's revenue laws.[6]

Tax treaties – a sword or shield?

5.5        Submitters suggested that treaty taxing powers were not intended to increase taxation within a jurisdiction, but were an agreement between States to avoid double taxation.

5.6        This limitation of the treaty powers suggested by submitters has been explained using a 'sword and shield' analogy whereby the treaty is used to 'shield' taxpayers and limit Australian taxation as opposed to a 'sword' to extend taxation.[7] In summary, the two arguments that surrounded debate on whether the bill made changes to the existing law, or merely clarified it, were presented as follows:

  • Treasury asserted that the bill clarified Parliament's intention that the tax treaties do provide an additional taxing power to make adjustments to transfer pricing assessments; and
  • other submitters suggested that the bill proposes changes to the existing law as the domestic law is the basis for taxation and the treaties should be used to relieve non-residents from Australian tax.

5.7        The committee received extensive evidence on the matter of Parliament's intention regarding tax treaty powers and the retrospective application of the bill. This chapter will highlight some of the key points raised by submitters including:

  • advice in the explanatory material for treaties;
  • representation of the two opposing interpretations of treaty powers in the EM;
  • views of the Joint Standing Committee on Treaties;
  • retrospective application of the thin capitalisation rules;
  • interpretation of subsection 4(2) of the International Tax Agreement Act 1953; and
  • interpretation of subsection 170(9B) of the Income Tax Assessment Act 1936.

5.8        The following chapter will provide evidence from Treasury which outlined various amending Acts that demonstrate Parliament's intention to use the treaties as a taxing power since 1982.

Explanatory material in treaties

5.9        GE asserted that none of Australia's major trading partners apply tax treaties as a separate basis for taxation. It also argued that Treasury's understanding that the treaties hold an additional taxing power has not been stipulated in explanatory material to the treaties:

Surely, to justify a law going back eight years and a significant departure from international practice, evidence of a clear and direct parliamentary intention should be required—such as, a clear statement in the explanatory memorandum to a tax treaty that the treaty can be applied to impose tax. Over 22 double-tax agreements and protocols have been signed since 1982, and not one of the EMs introducing these double-tax agreements has made reference to treaties providing a taxing power. In fact, the opposite appears to be the case. For example, the EM to the UK double-tax agreement specifically recognises that the purpose of Australia's tax treaties is to provide relief from double taxation.[8]

5.10      GE highlighted an extract from explanatory material for the 2003 tax treaty with the UK as an example:

What is the purpose of Australia's tax treaties?.... generally preserving the application of domestic law rules that are designed to address transfer pricing and other international avoidance practices ...[9]

A balanced approach to examining Parliament's intention

5.11      A number of submitters argued that Parliament's intention on the taxation power of treaties is not as clear as the EM to the bill portrays. They argued that the approach taken by Treasury is not balanced, and does not reflect other legislative amendments that suggest treaties do not have the taxation powers stipulated in the bill. Further, some highlighted that the EM does not consider explanatory material for treaties which express a contrary view (as discussed above).[10]

5.12      The CTAA suggested that the extracts used by Treasury do highlight that treaties have a taxing power, but not a taxing power to increase the amount of tax required to pay. It also argued that Treasury's interpretation and selection of material is 'unbalanced':

Look at the provisions that are actually quoted and the highlighted bits. Ignore, for the moment, what Treasury have been saying about how all this works and just read the things that have been quoted, in the context that the reference to the treaties. It is no more than saying the domestic law increases your income by $100, because of a transfer pricing adjustment, but if the treaty increases your taxable income by $70 then the treaty prevails. The treaty overrides the domestic law in that regard and you get a smaller adjustment. So yes, the treaty can be seen as imposing the $70 additional tax but it only works because that is a smaller amount than the $100 that the tax office was trying to apply under the domestic law. Depending on your mindset and how you choose to interpret this explanatory material, you get quite a different outcome.

I am not going to sit here like Treasury and say: 'It's been a clear and obvious intention of the government from as far back as 1982' because that is nonsense. Any objective person reading this could not possibly come to that conclusion. I am prepared to say that the evidence is equivocal but I am also suggesting that you should not have to read obscure amendments to mechanical provisions, like the entrails of a chicken, to come to the conclusion that the government wanted to impose taxing powers through treaties—something that no other country does... None of our treaty partners rely on treaties to make transfer pricing adjustments. You would have thought that if the government wanted to go that way they would have bothered to tell people rather than the remarkably obtuse way of doing it through the explanatory material.[11]

Taxation Laws Amendment Bill (No. 3) 1994

5.13      The Tax Institute cited paragraph 5.4 of the Supplementary EM to the Taxation Laws Amendment Bill (No. 3) 1994 as an example. It suggested that the extract demonstrated Parliament's intention that treaties should provide taxpayers with more favourable outcomes than that provided under domestic law:

5.4 The new Part assists a foreign bank in calculating the taxable income from its Australian branch by identifying certain amounts of income and expenditure that are properly to be regarded as attributable to the branch. If, however, a [Double Tax Agreement] DTA is applicable in relation to the bank and if in relation to the calculation of the taxable income of the bank for a particular year of income the outcome for the bank would be more favourable under the DTA than if the Part taken overall applied, then the bank will be free to choose that the new Part not apply in respect of the calculation of its taxable income for that year[12] (emphasis added by The Tax Institute).

5.14      The institute recommended that the EM to the bill should be amended 'to more accurately reflect differing views in the tax community and judiciary' and in particular that it should acknowledge the extract from the Supplementary EM to the 1994 tax law amendment bill.[13]

The Joint Standing Committee on Treaties

5.15      The Tax Institute also provided some extracts from reports of the Joint Standing Committee on Treaties that discussed whether tax treaties are intended to impose greater obligations on taxpayers than that of domestic tax law:

Report No.25 (dated 21 September 1999) Re: South African DTA: Paragraph 6.14 includes the following statement with respect to obligations imposed by the treaty: "In general, it does not impose any greater obligations on residents of Australia than Australia's domestic law would otherwise require."

Report No.28 (dated 23 November 1999) Re: Argentina DTA: Paragraph 5.13 states the following with respect to obligations imposed by the treaty: "The proposed Agreement does not impose any greater obligations on Australian residents than are imposed by existing domestic tax laws."

Report No.37 (dated 28 November 2000) Re: Russian DTA: The National Interest Analysis (Appendix B of the report) includes the following statement with respect to obligations imposed by the treaty: "In general, the Agreement does not impose any greater obligations on residents of Australia than Australia's domestic tax laws would otherwise require."[14]

Retrospective application of thin capitalisation rules

5.16      Some submitters argued that the provisions on thin capitalisation are 'outside the scope' of clarifying the law as the taxation ruling on which the provisions are based was not formalised until 2010, six years after the proposed year for retrospective application.[15] Deloitte stated:

A key component of the new legislation relates to the interaction of the transfer pricing rules with the thin capitalisation rules, and effectively legislates a position on which the Commissioner only provided his formal view in 2010. The thin capitalisation rules are particularly important for inward investors seeking certainty on the tax treatment of forms of foreign direct investment into Australia, and backdated changes in this area will be particularly damaging to Australia's reputation as an investment destination.[16]

5.17      Moore Stephens argued that the proposed debt, debt deduction and thin capitalisation provisions present a 'substantive change to the status quo' and quoted the EM to the bill:

Historically there has been "...no legislative provision specifically addressing the relationship between transfer pricing and thin capitalisation rules" [as stated in the EM, page 17.] To suggest that the retrospective nature of this element of the legislation is in any way justified is false. This element should only be implemented on a prospective basis...[17]

Interaction with subsection 4(2) of the International Tax Agreement Act 1953

5.18      Treasury has argued that subsection 4(2) of the International Tax Agreement Act 1953 (ITAA 1953) 'may result in the provisions of a Double Tax Agreement being applied instead of Division 13'.[18] Subsection 4(2) of the ITAA 1953 states:

The provisions of this Act have effect notwithstanding anything inconsistent with those provisions contained in the Assessment Act (other than Part IVA of the Income Tax Assessment Act 1936) or in an Act imposing Australian tax.[19]

5.19      An article provided by PwC highlighted that the Commissioner had initially relied on section 4 of the ITAA 1953 to support the argument that tax treaties hold a separate taxing power. The authors of the article explained, however, that this position had been challenged in GE Capital Finance Pty Ltd v the Commissioner. The article highlighted the decision of the court:

By the operation of s 4(1), the Agreements Act incorporates the Assessment Act subject to s 4(2). However, each Act retains its own identity and the imposition of the relevant tax is still imposed by and at the rates declared by the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974 (Cth) and the Income Tax Rates Act 1986 (Cth) by reference to the Assessment Act. The incorporation has the consequence, as a matter of a drafting technique, of incorporating the text of the Assessment Act into the Agreements Act (emphasis added by Collins et al).[20]

5.20      Treasury's position on subsection 4(2) of the ITAA 1953 is discussed further in the following chapter on Parliament's intention.

Subsection 170(9B) of the Income Tax Assessment Act 1936

5.21      To illustrate Parliament's intention on treaty taxing powers, Treasury highlighted subsection 170(9B) introduced into the Income Tax Assessment Act 1936 (ITAA 1936) as part of the 1982 amending Act which introduced Division 13.[21]

5.22      Subsection 170(9B) allows for adjustments to transfer pricing assessments to consider Division 13 or a 'relevant provision' which is defined as the associated enterprises and business profits articles contained in Australia's tax treaties.[22] Subsection 170(9B) states:

Subject to subsection (9C), nothing in this section prevents the amendment, at any time, of an assessment for the purpose of giving effect to a prescribed provision or a relevant provision (emphasis added by Treasury).[23]

5.23      The PwC article suggested that Treasury's position is 'not supported by the rules of statutory interpretation':

...although seemingly persuasive, the s 170(9B) position is not supported by the rules of statutory interpretation, as it unnecessarily departs from the literal meaning and operation of the provisions. It also fails to recognise that the legislative intention noted in the EM to s 170(9B) was affected by the erroneous assumption that s 4 of the Agreements Act was effective in incorporating the Agreements Act into the Assessment Act. Furthermore, the position is inconsistent with Parliamentary documents which relate to Australia's DTAs, case law and international practice...

...s 170(9B) and (9C) need to be interpreted in the broader context of ss 169, 170, 173 ITAA36, the decision in GE Capital, and s 170(11) ITAA36. In particular, the subsections need to be interpreted in the context of the Commissioner's general power of assessment under s 169, as modified (limited) by s 170...

The confusion regarding the effect of s 170(9B) and (9C) arises from the erroneous assumption, which existed at the time these subsections were introduced, that s 4 of the Agreements Act effectively incorporated the Agreements Act into the Assessment Act and that, consequently, art 9 needed to be applied in priority to Div 13 ITAA36 in some instances. This is reflected in the EM to s 170(9B) and (9C). However, the EM is clear that the aim of the subsections was only to provide the Commissioner with a power, which it was perceived he had, as a result of s 4 of the Agreements Act. Where the Commissioner does not have this power, it is inappropriate to infer such a power.[24]

5.24      In addition, the authors of the article highlighted their understanding that written submissions lodged with the Administrative Appeals Tribunal in Roche Products Pty Ltd v Commissioner (2008) by both parties addressed the issue of the taxing power of treaties under section 170:

The Commissioner's view relying on s 170(9B) was fully explained and considered by the Tribunal. In this regard, having considered the s 170(9B) position, Downes J stated:

"...there is a lot to be said for the proposition that the treaties, even as enacted as part of the law of Australia, do not go past authorising legislation and do not confer power on the Commissioner to assess. They allocate taxing power between the treaty parties rather than conferring any power to assess on the assessing body. On this basis Division 13 should be seen as the relevant legislative enactment pursuant to the power allocated" (emphasis added by authors of article).[25]

5.25      The ATO acknowledged that there had been two cases which specifically addressed the operation of treaty powers in relation to transfer pricing in obiter:[26]

  • Roche Products Pty Ltd v Commissioner of Taxation in 2008 before the Administrative Appeals Tribunal (as discussed above);[27] and
  • SNF Australia Pty Ltd v Commissioner of Taxation.[28]

5.26      Treasury emphasised, however, that discussion on treaty based transfer pricing rules were limited to obiter comments.[29] Treasury highlighted that in Roche, Justice Downes 'clearly prefaces this statement with the qualification that he was not required to decide on the issue'.[30]

5.27      In contrast to the comments in Roche, Treasury noted obiter comments  in the SNF case by Justice Middleton specifically in regard to subsections 170(9B) and 170(14) of the ITAA 1936 which stated:

As the stand alone taxing power issue was raised in written submissions, I make the following very brief comment. I do see some force in the argument that by operation of s 170(9B) of the ITAA and the terms "prescribed provision" and "relevant provision" as defined in s 170(14) of the ITAA, there is a clear legislative intention (at least from the time of the introduction of s 170(9B)) that the Commissioner may in amending an assessment, rely on either s 136AD or the relevant associated enterprises article, as conferring upon the Commissioner, as a separate power, a power to amend an assessment. I say this although there is no provision expressly stating that "the relevant provision" (namely, the associated enterprises article) has been incorporated into the ITAA. However, it seems to me that the express words in the ITAA necessarily and naturally imply the required incorporation of the relevant associated enterprises article into the ITAA.[31]

5.28      The following chapter will discuss various amending Acts that, in opposition to the views of submitters presented above, demonstrate Parliament's intention to use the treaties as a taxing power dating back to 1982. The chapter will then conclude with the committee's view of Parliament's intention on treaty based transfer pricing rules.

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