What tax law changes are being proposed in relation to royalty payments?

In preparing for this month’s federal election, the Opposition party, The Australian Labor Party, has announced this last week, that it intends to change the laws in Australia to regulate multinationals who transfer from their Australian entities to their overseas entities royalty payments and services charges relating to intellectual property. Specifically, Labor’s announced fiscal plan has stated that it will introduce “Royalty Integrity” to stop multinationals from getting a tax deduction when they “unfairly funnel royalty payments” to arms of their own company that pose a multinational tax risk.

Which royalty payments will be impacted?

It appears that the royalty payments most in focus will be those intellectual property royalties which are paid to entities in low tax jurisdictions, such as those on Labor’s proposed “blacklist” which includes the Cayman Islands, Bermuda, Andorra, Liechtenstein, Guernsey, Monaco, Mauritius, Liberia, Seychelles, Brunei, Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, British Virgin Islands, Grenada, Montserrat, Panama, St Vincent and the Grenadines, St Kitts and Nevis, Turks and Caicos and the US Virgin Islands. The laws, if enacted, would reportedly save Australian tax payers AUD$2.3 billion over the next 10 years. Labor’s press release also referred to transactions which incur low or no tax because the licensee and licensor take advantage of tax regimes such as 'patent boxes'. A patent box is tax regime which provides a low corporate tax – designed to incentivise research and development as patent revenues will be taxed at a lower rate that other revenues. Countries with patent or other intellectual property box tax regimes include Cyprus, Ireland, France, Netherlands, Belgium, Luxembourg, Hungary, Spain and the United Kingdom. The patent box regimes have been criticised as assisting multinationals to avoid or minimise their corporate tax.

How will the royalty payments be impacted?

Labor has stated that its policy will apply to stop multinationals receiving a tax deduction for royalties when they are paid by a firm with AUD$1 billion or more global turnover to a related party in a transaction which will be subject to the "sufficient foreign tax test" aspect of the Australian Diverted Profits Tax or which has a harmful 'patent box' regime. Labor intends that a tax deduction will still be available if it can be evidenced that the royalty payments would not be for the dominant purpose of tax avoidance.