There has been a lot in the news lately about the low tax paid by some multinational corporations, including Starbucks and Google. These multinationals say that they are complying with the tax laws of all countries.
A recent Australian High Court case reveals the challenge facing national governments in trying to fix the international tax system to capture profits earned by multinationals around the world.
In this test case involving complex and technical Australian company tax rules, the High Court was asked to consider how rules these applied to the Commonwealth Bank of Australia’s controversial $2 billion capital raising in 2009.
The outcome was that CBA was legally able to reduce the cost of its capital raising – while both the Australian and New Zealand governments lost out on tax revenue.
At the time, most media attention around CBA’s capital raising centred around allegations it failed to disclose price sensitive material to the market, leading to a $100,000 fine by ASIC.
But the securities on offer, PERLS V securities were also notable for their complex “stapled” structure, comprising a preference share issued by the CBA, and a note issued by the bank’s New Zealand branch.
Under the issue, an investor was entitled to quarterly distributions of interest on the notes, plus a franking credit on the preference share. The interest was paid by the New Zealand branch of the CBA, which issued the notes. The franking credit reflected underlying Australian company tax paid by the bank as an Australian taxpayer.
A major reason for this structure was tax. The securities were treated differently in Australian tax law, compared to New Zealand tax law – we sometimes call this “hybrid” tax treatment and as the OECD identifies, it’s a challenge for tax systems.
Under Australian tax law, the PERLS V securities are treated as equity not debt, so although the return on the security was called “interest”, distributions were treated like a ordinary share dividend for tax purposes and carried a franking credit.
But under New Zealand income tax law, the note that formed part of the PERLS V securities was analysed on its own, separately from the preference share, and it was treated as debt.
This meant that in New Zealand, when the CBA branch paid interest on the note, that interest was deductible against profits of the New Zealand branch. As a result, the New Zealand branch paid less tax to the New Zealand government.
The economic advantage of this complicated structure is that the CBA was able to obtain high quality capital at a cheap price. The cost of raising capital using the PERLS V security was estimated by the bank as 5.86%. This compared to the economic cost of an ordinary issue of shares of 14.2%. That’s quite a saving.
For investors, it’s the franking credit combined with the higher rate of the “interest” return – which was above basic interest rates – that is really attractive, allowing them to reduce tax on their income.
The full bench of the Federal Court at first ruled in favour of Australia’s Tax Commissioner, finding that a tax anti-avoidance rule directed at franking credit schemes to avoid tax, could be applied.
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