Tax Alert: Potential Double Taxation For Us Multinationals

Australian tax ruling highlights potential for double taxation for US multinationals with US and Australian operations

The Australian Taxation Office (ATO) has recently released a final determination – TD 2022/9 – dealing with the operation of Australia’s hybrid mismatch rules and its interaction with section 951A of the US Internal Revenue Code (“Global Intangible Low-Taxed Income” or “GILTI” rules).

The position taken in TD 2022/9 potentially means that US multinationals operating in Australia can, in certain situations, result in double taxation because of the way Australia’s hybrid mis-match rules operate as interpreted by the ATO.

This article has been prepared by the tax experts at Bentleys (Australia) and Weaver (US).

As members of Allinial Global – an international association of independent accounting and consulting firms – Bentleys and Weaver belong to a worldwide community of professionals who work together to deliver best-in-class solutions to meet clients’ business needs.

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What are Australia’s hybrid mis-match rules?

Australia’s hybrid mis-match rules were introduced as a result of adopting OECD recommendations (OECD Action Report 2) to eliminate tax arbitrage opportunities that could otherwise arise between different tax jurisdictions.

The hybrid mis-match rules are complex, but in broad terms are designed to counter arrangements that might otherwise allow a multinational to claim a deduction for the same amount in more than one country (deduction/deduction mis-match) or where a deduction is claimed in one country but not being taxed in another (deduction / non-inclusion mis-match).

Where a hybrid mis-match occurs – such as a deduction / non-inclusion mis-match – the hybrid mis-match rules can operate to deny a deduction in Australia to eliminate the double benefit arising.

However, the amount of a mis-match can be reduced by amounts referred to as “dual inclusion income”. This limits any denial of deductions under the hybrid mis-match rules.

In simple terms, this means that if a double deduction arises in two tax jurisdictions, the hybrid mis-match rules will not operate to deny deductions if there is also a corresponding income amount taxed in both jurisdictions – this is referred to as “dual inclusion income”.

Broadly, an amount can be considered “dual inclusion income” if that amount is subject to Australian income tax and is also “subject to foreign tax” in a foreign country from an Australian tax perspective.

Meaning of “Subject to Foreign Tax”

The key issue addressed by TD 2022/9 is whether income that is taxed under the US GILTI rules would be considered as being “subject to foreign tax” for the purposes of Australia’s hybrid mis-match rules.

Australia’s hybrid mis-match rules specifically include an amount as being “subject to foreign tax” if it corresponds to Australia’s Controlled Foreign Company (CFC) rules which tax certain types of income in Australian-controlled foreign companies. The issue then becomes whether the US GILTI rules correspond to Australia’s CFC rules.

The US GILTI rules include certain income amounts of US-controlled foreign companies in the US tax base. The objective of these rules is to discourage the shifting of profits outside the US that can otherwise be easily moved offshore such as intellectual property and other intangibles.

Notwithstanding the apparent similarities between the US GILTI rules and Australia’s CFC rules, the ATO considers otherwise and that the US GILTI rules do not correspond to Australia’s CFC rules based on a deeper analysis of both rules.

This means that the ATO does not accept amounts taxed under the GILTI rules as being “subject to foreign tax” for the purposes of Australia’s hybrid mis-match rules.

What is the effect of TD 2022/9?

In short, TD 2022/9 means that multinationals with US and Australian operations can potentially be subject to double taxation. This can include where deductions may be denied in Australia under the hybrid mis-match rules if the same amount is also claimed offshore, notwithstanding there are corresponding amounts taxed under the US GILTI rules.

That said, the hybrid mis-match rules are significantly complex. There may be other provisions available under the rules to avert the potential double taxation impact of TD 2022/9, for which expert advice should be sought.

Does the recent Inflation Reduction Act (“Act”) in the US provide relief from double taxation caused by the interplay of US GILTI rules and Australia hybrid mis-match rules?

The Biden administration had proposed that the US GILTI rules be reformed to increase the rate of tax on profits of subsidiaries of US companies from 10.5 percent to 15 percent. Further, it was proposed that this be implemented at a country-specific level to align more closely with the OECD “Pillar Two” global minimum tax deal that was agreed to by 136 countries, including the US, in October of 2021. Ideally, the proposed changes might have provided some relief from the aforementioned Australia and US hybrid mis-match driven double taxation.

Australia is an example where US companies with Australian subsidiaries may have double taxation issues related to the US GILTI rules, though this fact may cause similar double taxation risk in other jurisdictions if other foreign taxing authorities take the same view as the ATO.

With President Joe Biden signing the Inflation Reduction Act of 2022 (“Act”) into law on August 16, 2022, the key tax law change imposing a 15 percent minimum tax on certain US corporations is now more clearly defined. The new 15 percent minimum tax rule did not address factors that underpin the US GILTI and Australia hybrid mis-match rule double taxation issue, but the structure of the 15 percent corporate minimum tax may pose additional complexity and difficulty in the context of US alignment with the OECD’s global minimum tax framework, commonly referred to as “Pillar Two”.

How is the US 15 percent minimum tax rule structured?

The Act amends the alternative minimum tax (AMT) under IRC Section 55, effective January 1, 2023, to impose a “tentative minimum tax” on “applicable corporations” equal to the excess of:

• (1) 15 percent of the “adjusted financial statement income” (AFSI) over
• (2) the corporate AMT foreign tax credit for the subject tax year.

If an applicable corporation’s tentative minimum tax exceeds its regular tax liability, then it must pay the difference as AMT.

What constitutes an Applicable Corporation?

An applicable corporation is generally any corporation (other than an S corporation, a regulated investment company, or a real estate investment trust) with an average annual AFSI of more than $1 billion for the three preceding taxable years ending with the subject tax year. This annual AFSI test is applied to tax years ending after December 31, 2021.

In determining whether a corporation meets the $1 billion threshold, the AFSI of all persons treated as a single employer with such corporations under IRC Section 52 generally is treated as the AFSI of the subject corporation. The income is determined without regard to the adjustments for partnerships under Section 56A(c)(2)(D)(i) and defined benefit pensions under Section 56A(c)(11).

For corporations in existence for less than three tax years, the threshold test applies to the period in which the corporation has existed. For short tax years, AFSI is annualized.

A corporation can be exempted from the minimum tax if it has a number of taxable years (to be specified by regulation) in which its AFSI does not meet the threshold and the Treasury Secretary determines that it would not be appropriate to apply the minimum tax. The Treasury Secretary’s determination would not apply if the corporation meets the three-year average annual AFSI threshold for any taxable year beginning after the first taxable year for which the exemption was granted.

Certain foreign-owned corporations with AFSI over $100 million are also subject to the minimum tax.

What is adjusted financial statement income (AFSI)?

The Act defines AFSI (under the newly added IRC Section 56A) as the taxpayer’s net income or loss as reported on the taxpayer’s applicable financial statement (as that term is defined in IRC Section 451(b)(3) or in future regulations) for the year. Numerous adjustments are to be made to AFSI, including adjustments for:

• statements covering different tax years;
• related entities;
• certain items of foreign income;
• effectively connected income;
• certain taxes;
• disregarded entities; and
• income from partnerships.

AFSI is also reduced by accelerated depreciation deductions and for amortization deductions related to qualified wireless spectrum. The adjustment for accelerated depreciation means depreciation deductions have the same effect on a corporation’s tax base for AMT purposes as they do for regular tax purposes, including any benefit of bonus depreciation under IRC Section 168(k). This adjustment is beneficial for any year in which the depreciation deduction for tax purposes is greater than the depreciation deduction for book purposes.

Additionally, AFSI is decreased by the lesser of:

(1) the aggregate amount of financial statement net operating loss (NOL) carryovers to the tax year; or
(2) 80 percent of AFSI computed without regard to financial statement NOLs.

A financial statement NOL for any tax year may be carried over to each tax year following the tax year of the loss. “Financial statement NOL” is defined as the amount of net loss on the corporation’s applicable financial statement, after applying the AFSI adjustments, for tax years ending after December 31, 2019.

Other than the adjustments described here, a taxpayer’s AFSI generally does not take into account other tax provisions. For example, AFSI is not adjusted to reflect:

• Limitations on interest expense deductions under section 163(j);
• Limitations on deductions for certain employee remuneration that exceeds $1 million under section 162(m); or
• Limitations on loss carry forwards under section 382.

We note that general business credits under IRC Section 38 (e.g., the research and development tax credit) are allowed for AMT purposes in the same manner as allowed for regular tax purposes, thereby preserving the value of general business credits.

In addition, similar to the prior AMT, any AMT paid by a taxpayer generates an AMT credit that can be utilized against the taxpayer’s future regular tax liability. The amount that can be utilized in a tax year is limited to the excess of the taxpayer’s regular tax liability over its tentative minimum tax.

What are the OECD’s global minimum tax rules?

The so called “Pillar Two” global minimum tax (GloBE Rules) include an implementation floor of 15 percent minimum tax rate, income based on financial accounting with defined adjustments, and a €750 million threshold for in bringing companies in scope of the rules.

The structure of the rules involve multiple rules to accomplish the minimum tax policy.

• Subject to Tax Rule (STTR) which is a rule designed to deny treaty benefits for certain intercompany transactions subject to tax rates below the minimum (currently targeting interest and royalties).
• Global Anti-Erosion (GloBE) Rules provide two connected rules to accomplish minimum tax policy objective where STTR is not applicable.
• The Income Inclusion Rule (IIR) is a top-up tax on a parent entity in respect to the low taxed income of a subsidiary. It is the primary rule of the GloBE rules. (Conceptual similarities to US GILTI regime, only tied to foreign income)
• The Under Tax Payment Rule (UTPR) denies deductions or similar adjustments where low tax income is not subject to the IIR, primarily where parent companies’ jurisdiction doesn’t implement the IIR. UTPR is the secondary rule of the GloBE rules and ensures the minimum tax is also applied domestically on a parent entity.

Does the Act provide alignment with OECD’s global minimum tax deal?

The US corporate minimum tax signed into law appears to have gaps that may cause misalignment with GloBE Rules potentially leading to exposure for the United States tax base whereby foreign governments that implement rules aligned with “Pillar Two” may be able to collect a top up tax from US companies given differences, including the aggregate nature, of the US corporate minimum tax from “Pillar Two.” There could also be a top up tax on the rate differential between the US GILTI rate of 10.5 percent and the “Pillar Two” minimum tax rate of 15 percent.

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Disclaimer: This information is general in nature and should not be relied on as advice. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs and seek professional advice before making any decisions based on this information.