How do you define a small business? Would you consider a business small if, for example, it was a multinational corporation with equity of, say, $15 million, whose Australian arm had borrowed $20 million from its offshore arm?
Probably not. And nor would the federal government, in most circumstances. But the Abbott government took an expansive view of what constituted a “small business” recently when it announced its intention to abandon some of the measures proposed by the former Labor government to discourage corporate tax avoidance.
We are talking in particular about section 25-90 of the tax act, the “thin capitalisation” rules. The term is eye-glazingly anodyne, but the tax rort to which it refers is pretty simple.
“That’s where a company structures its operations so it loads up a subsidiary with debt – money borrowed from a related company offshore – and then claims the interest as a tax deduction. That reduces the profits in Australia and shifts them offshore,” says Mark Zirnsak, director of the Justice and International Mission Unit of the Uniting Church, an expert in the many and varied ways by which multinational companies dodge tax.
The previous government’s last budget announced steps to limit this form of corporate tax avoidance, reducing the amount of debt that could be loaded onto the Australian arms of multinational companies by halving the allowable debt to equity ratio. Once your ratio passed 1.5 to 1, and your total interest repayments exceeded $250,000 a year, the taxman would start asking hard questions.
Treasury calculated that the government would claw back about $1.5 billion in revenue over four years as a result of the change. But Labor did not manage to get the legislation through before it was tipped out of office.
Tony Abbott and Joe Hockey both paid lip service to the reform agenda. In his January address to the World Economic Forum in Davos, Switzerland, the new prime minister acknowledged countries’ tax regimes had “not always kept up with the rise of services and the pervasiveness of digital technologies” allowing multinationals to “take advantage”.
He promised: “The G20 will continue to tackle businesses artificially generating profits to chase tax opportunities rather than market ones.”
At the G20 finance ministers’ meeting in Sydney in February, Hockey declared: “Some companies – some global companies – aren’t paying their fair share of tax anywhere. We want a global response. The globe needs to know who’s paying tax where.”
But there are words, and there are actions. The incoming Abbott government promptly announced it would make changes to Labor’s “thin cap” proposal, and increase the de minimis threshold for interest repayments eightfold, from $250,000 to $2 million. The purported reason was to spare small business compliance costs. Which rather redefines the term “small business”, says Zirnsak.
“I ask you, how many small businesses do offshore interest repayments of $2 million? It doesn’t sound like your corner fish and chip shop.”
No indeed. The winners from this change are multinational companies worth tens of millions in combined debt and equity. That’s not small by any of the usual definitions.
Nor is the cost to government revenue small: an estimated $600 million. Add in a couple of other anti-avoidance measures that the new government has wound back and the amount of forgone revenue comes to about $1.1 billion.
Says tax law expert Antony Ting, from the University of Sydney Business School: “This government appears to be less eager than its predecessor in closing a tax loophole that allows deduction of interest expenses incurred to generate exempt dividend income.”
And there were other indications in the budget, too, of the government’s attitude. Two of the agencies most heavily hit by its cuts to the public service were the tax office, slated to have its staff reduced by 2300, or about 10 per cent, and the corporate watchdog, the Australian Securities and Investments Commission, down about 200 staff, or 11 per cent.
While the companies that will benefit from the relaxation of the debt threshold are not really small businesses, they are not huge, either. And that’s the real point: in the new, wired world, tax avoidance has become an option for lots of people.
When people think about corporate tax avoidance, they tend to think of giant corporations such as Apple and Google that dodge tax on a truly Homeric scale.
You might have seen the news reports a year or so back about Google’s filing to ASIC, showing it had paid just $74,176 in tax in Australia on estimated revenue of somewhere close to $1 billion. Had it paid the full corporate rate, and not managed to move profits offshore, it would have been up for as much as $300 million.
In a recent analysis for the British Tax Review, Ting describes how Apple employed a somewhat different strategy to shelter $US44 billion between 2009 and 2012 from taxation anywhere in the world. He calls it the “iTax” scheme.
An example of how it works: when someone in Australia buys an iPad for $600, it is recorded as revenue by the distribution subsidiary here. But this company “purchases” the iPad from another Apple subsidiary incorporated in Ireland for $A550.
“The Irish subsidiary is basically a shell company with no employees and no factory. The iPad was manufactured through third-party contract manufacturers in China, who shipped it directly to Australia,” writes Ting.
The two salient points here are that Ting concludes that the US government has been “knowingly facilitating the avoidance of foreign income tax by its multinationals”, and that in tax avoidance, as in so many other areas, where the US leads, others follow, even if they don’t use exactly the same methods.
Companies everywhere have become much more aggressive about minimising their tax. Last year Mark Zirnsak set out to compile a list of tax-haven subsidiaries of Australia’s top-100 companies. He found hundreds of them.
All the big banks had them. Some companies had many: AMP had 15, Computershare 18, Telstra 19, Downer EDI 32, Toll Holdings 64, Goodman group 67. Way out ahead of the pack was Rupert Murdoch’s News Corp with 146.
None of this indicates illegality. And that’s just the problem. Multinational corporations and their enablers in big accounting and legal firms have proved very adept at moving money around the world, arbitraging different tax systems.
Sometimes they do have legitimate operations in low tax jurisdictions. But often not.
Zirnsak, in association with various tax experts, is trying to update the list to give a better idea of just how “aggressive” the tax arrangements of various companies are. It’s proving difficult, though.
“I hadn’t realised [at the time of doing the first list] that Australian companies aren’t required to disclose all their subsidiaries unless they deem them ‘material’ to their operations,” he says. “So if a company decides laundering $10 million through a secrecy jurisdiction in order to avoid paying tax is not material to its operations, it needn’t reveal that subsidiary.
“Westfield, for example: we identified 56 subsidiaries in their 2010 report. If you look at their 2013 report, they don’t disclose a single subsidiary in Jersey or Luxembourg, even though we know they have them.”
A recent investigation of Westfield’s tax affairs for the union United Voice found the Westfield Group’s average corporate tax rate was just 8 per cent over the nine years to December 2013, compared with an average 22 per cent for Australia’s other top-200 companies.
The big picture here is that corporate tax avoidance is a massive global problem, although no one knows exactly how big. But in a report out last year the OECD left no doubt about its seriousness: “What is at stake is the integrity of the corporate income tax.”
Having done not very much about it over a long time, the world governments and their collective entities, such as the OECD and G20, are now moving to address the problem, which they refer to by the acronym BEPS, for base erosion and profit shifting. And some progress has been made.
First, says deputy tax commissioner Mark Konza, Australia actually has one of the better regimes, as it must, given roughly half our GDP is in international trade, and half of that is between related parties. He says that is thanks to action by a succession of previous governments, notably the previous one.
Reforms passed last year, under Labor, give us what he calls “effectively the most modern and effective transfer pricing rules in the world”. From next year, the tax office will start publishing more detail of the tax actually paid by companies with revenue of more than $100 million.
As for the current government, he says, we’ll wait and see what comes out of its white paper on taxation. And as for the decision to walk back the thin capitalisation rules, he is diplomatic: “Where the limit is put is a matter for government.”
On the international front, says Konza, progress is also being made. The agreement of common reporting standards and the automatic exchange of information between tax authorities, he says, “is going to be very important for ensuring an end to bank secrecy”.
“My observation is that countries are becoming very sensitive to being identified as secrecy jurisdictions.”
The larger countries are increasingly realising the need to be more open. And the little countries will find themselves increasingly marginalised over time.
“I won’t comment on other countries, because I have to deal with them … but I can comment that the British prime minister brought all the British protectorates in and told them all, as a group, to join up.”
He might not name them, but he’s talking about places such as the British Virgin Islands and Cayman Islands, through whose secretive financial system trillions of dollars are currently laundered for tax-avoidance purposes.
The next big step, Konza hopes, will be mandatory country-by-country reporting by multinationals, which will make profit shifting much more obvious.
“I think that’s an important development, especially for the developing world, who perhaps don’t get a very good picture of companies’ international transactions and arrangements,” he says. “I think there will be substantial progress both this year and probably more next year … [but] we’ll be working on this for a long time yet.”
Ultimately, says Konza, “It’s more of a diplomatic and political process than a technical process”.
In other words, what we need is governments that are open to reform, not just open for business.