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Chapter 33: Allocating worldwide taxable income between countries

The challenge for
taxation policy

The allocation of income and deductions among countries is crucial to international taxation. Australia’s source rules for income and deductions lack a degree of certainty and transparency. This can impose costs on businesses without ensuring that Australia receives an appropriate share of global business tax revenue.

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A strategy for reform

To improve the operation of the existing source rules to add to certainty for business and to ensure Australia receives an appropriate share of global business tax revenue that reflects value added in Australia.

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Key policy issues
Should there be clearer rules to determine the source of income? Should Australia allow deductibility of interest for offshore investments? How should the thin capitalisation provisions for onshore investment be tightened? What improvements can be made to the administration of the transfer pricing rules? How should the taxable income of branches be determined? What improvements can be made to record keeping requirements? Should deductions be disallowed in the absence of sufficient information?
Option 1
A substance over form approach.

Option 2
A specific rule approach.

Uncertainty regarding the source of gains on realisation of assets could also be reduced.

Option
The imputation system provides an incentive
to pay Australian rather than foreign tax.

Nevertheless, Australia could consider rules to limit deductibility of interest in highly geared controlled cases.

Options
Deny interest deductions if gearing exceeds: - worldwide ratio (Option 1); or - fixed ratio (Option 2).

Both options would allow further deductions in certain instances.

Options
Consider the application of self-assessment principles to transfer pricing.

Address gaps in the current law in relation to corresponding relief.

Consider how to avoid disputes and resolve those that do occur.

Options
Replace the present single entity approach with a separate entity approach to calculating the taxable income of branch operations in Australia.

Extend that approach to include withholding taxes

Options
Standardise record keeping requirements with our major trading partners.

Tie the penalty regime for transfer pricing adjustments to the level of documentation available.

Option
Deny deductions for expenditure incurred
in low tax countries that do not exchange information in the absence of the necessary documentation to validate the transaction.