Australia’s Focus on Data Centers Marks New Global Tax Frontier

As data centers become a crucial part of global digital infrastructure, revenue authorities worldwide are increasing scrutiny of how such operations may be taxed.

There are several emerging issues that will arise when applying legacy tax rules to the modern realities of cross-border cloud computing and the artificial intelligence services generating increasing demand for computing power. When positions of revenue authorities fail to align, it can result in double taxation.

For multinational groups, this means the tax treatment of data centers isn’t just a local issue, but a global one.

Australia is no exception—if anything, the Australian Taxation Office is leading the charge, armed with funding, resources, and broad legislative powers that exceed many of its international counterparts.

ATO Focus

The ATO’s scrutiny of data centers is the latest installment of the agency’s focus on intangible assets, such as software and software-as-a-service platforms, consumer products, know-how transfers, and brands.

The ATO perceives data centers as a fundamental and valuable part of a corporation’s broader enterprise, and noted that they don’t view data center operators as merely providing low-value services to offshore group members. They also see the use of intellectual property in Australia, such as the know-how and software used to run data centers, and have concerns that royalty withholding tax isn’t paid under the typical structures seen in the industry.

The agency has demonstrated that it will pursue novel arguments in the intangibles space, which test the boundaries of existing law. This is most evident in its draft ruling issued last year asserting that most payments made by software distributors should be characterized as royalties, which stands in contrast with the OECD consensus and the US’ views.

The ATO has flagged a suite of tools that it can use to pursue those questions—Australia’s broad general anti-avoidance rule, the diverted profits tax, transfer pricing (including recharacterizing the transactions actually entered into), attributing income to actual or deemed permanent establishments, asserting that foreign entities derive Australian-source income, and royalty withholding tax.

Ultimately, outcomes will depend heavily on the circumstances of each individual case, such as the type of technology, the IP involved, the business model and its evolution, the specific functions of the Australian entities, and the level of involvement of other entities within the broader group.

In a ‘Cluster’

When revenue authorities examine industry-wide tax issues, they often group taxpayers into clusters before reviewing specific cases. Being a “clustered” taxpayer means you have less control of the review’s timing and direction.

The ATO’s public comments on its review of data centers resemble its earlier campaigns targeting marketing hubs and financing arrangements. As was the case for those clusters, the ATO has embarked on a process of developing its views while conducting a serious of reviews, starting with standardized questionnaires followed by more targeted information requests.

That approach involves the ATO building cases and its understanding of the industry on a collective basis, learning from each taxpayer to develop a position likely to be applied across the industry.

Internal stakeholder engagement and support is essential in such emerging situations. Cases involving data centers can involve higher than usual levels of uncertainty around the process, the issues that will be raised by the ATO, and—more broadly—in terms of resources and case management. This uncertainty means that the key questions that typically guide case management and strategy may not have immediate answers:

• What is the ATO’s likely position?
• What facts and evidence are needed to address arguments raised by the ATO?
• How does our position align with those taken by the company and other revenue authorities in other countries?
• What are the risks if other revenue authorities agree or disagree with the ATO?
• How do we address the risk of double taxation?

The answers to these complex questions will only become apparent as the review process unfolds, and may shift over time. Multinational groups should leverage the longer timeframes inherent in cluster reviews to their strategic advantage. There is an opportunity to gather and test the relevant facts, and to solidify legal and evidentiary positions, before the ATO position is finalized.

A key part of developing a robust case in this space is to marshal the evidence on why a business structure has evolved into its current form, including the commercial drivers underpinning the structure—and important factors such as geographic, regulatory, and technical constraints.

The emergence of data centers as a focus area will likely give rise to disputes as revenue authorities and taxpayers will need to handle novel and untested legal issues. At the end of the day, like all tax disputes—novel or not—much will depend on the evidentiary building blocks supporting the tax position that is being scrutinized.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Niv Tadmore is a partner at Jones Day in Melbourne focusing on tax audits, tax disputes and large-scale transactions.

Benjamin Lancaster is of counsel at Jones Day in Melbourne who focuses on tax audits and tax disputes.

Alice Robertson is an associate at Jones Day in Melbourne who focuses on tax disputes.

These are personal views or opinions of the authors; they do not necessarily reflect views or opinions of Jones Day.

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