‘Hugely complex’ new global minimum tax likely to cost New Zealand more than it yields

Revenue Minister Simon Watts has plumped a new global minimum tax regime, but experts say it's likely to cost New Zealand more than it yields. Photo / Alex Burton

The cost of a new global tax regime will likely outweigh the benefits in New Zealand during the early years of implementation and perhaps indefinitely, a Kiwi tax expert has warned.

From January 1, New Zealand subsidiaries of offshore-headquartered multinationals and large New Zealand multinationals have had to pay a minimum 15% in corporate income tax in the jurisdictions where they operate, if they had revenue over €750 million ($1.38 billion) in two of the past four years.

And the global movement to use the regime could decline significantly with the return of Donald Trump to President of the United States on January 20.

Where it started

In the early months of 2021, Janet Yellen, the newly minted US Treasury Secretary, called for a global minimum corporate tax rate to stop multinational companies from shopping around for the best tax deal.

Yellen stressed that the US was interested in restoring its economic leadership in the world following the unilateralism of Trump’s presidency. And that included ending what she called a “race to the bottom” through tax sheltering, loopholes, and avoidance.

Yellen, and the Biden administration more generally, were interested in raising America’s 21% corporate tax rate at the time, which sharpened the interest in ending international tax competition between countries.

It was a major shot in the arm for an Organisation for Economic Co-operation and Development (OECD) idea that had previously struggled to gain traction without Washington’s support.

However, Yellen and her boss, US President Joe Biden, never got past the step of agreeing to the plan in principle.

Most European countries (including low-tax jurisdiction Ireland) and a slew of others ranging from Australia and New Zealand to Britain, South Korea and Japan have signed up and legislated for the new system. Implementation is in its early stages.

But the ground in Washington has shifted: Biden and Yellen are out, and on January 20 President-elect Trump will return to the White House.

By all indications, Trump’s interest in multilateralism remains low, and his appetite for punishing countries that raise special tax measures against US-based corporations may prove considerable – trade and tariffs are likely to be his preferred artillery.

(It’s also worth noting that the US has its own unilateral measures to combat profit shifting and ensure its largest companies pay a minimum tax rate on foreign earnings – these are generally less stringent than the OECD-led system.)

Whether Trump seeks to roll back the emerging global regime remains to be seen, but experts expect it’s on the cards.

President-elect Donald Trump may seek to roll back the emerging global minimum tax regime, experts say.

New Zealand’s ‘Pillar Two’ rules

Like dozens of other countries, New Zealand has passed legislation that essentially adopts the OECD “Pillar Two” rules, also known as the “global base erosion rules”, aimed at stopping tax-base erosion and profit shifting, which arises when companies shift profits to low-tax jurisdictions.

The law was passed under the last Government but is supported by the current coalition and by Revenue Minister Simon Watts.

Starting on January 1, the very largest of New Zealand head-quartered multinational companies have had to pay a minimum 15% in corporate income tax in the jurisdictions wherein they operate. Only companies with revenue over €750m in two of the past four years are affected.

If an effective tax rate in any jurisdiction wherein these companies operate is below 15%, a top-up tax applies, according to a hierarchy of rules.

Sandy Lau, PwC tax partner based in Wellington, told the Herald that in New Zealand’s case, a domestic income inclusion rule will allow the Government to collect “top-up tax” on undertaxed profits.

The change stands to affect two types of taxpayers. The largest of New Zealand’s locally headquartered multinationals – the likes of Fonterra and Mainfreight – will need to comply.

And the rules also apply, at least notionally, to the New Zealand subsidiaries of offshore-headquartered multinationals.

However, New Zealand’s corporate tax rate is 28%, and enormously higher than the new minimum; it’s unlikely that any additional tax would be collected from this second group.

The Inland Revenue estimates that a system to monitor the new minimum tax rules will cost $11m to adopt, and $3m a year to operate.

Costs to NZ likely outstrip the benefits

Remarkably, Lau said she thinks it’s very likely that the costs of this tax change will outweigh the benefits in New Zealand, certainly during the early years of implementation and perhaps indefinitely.

“This is a hugely complex regime, and we’re asking companies to provide data that they haven’t collected before, so the compliance costs on the corporate side are very high ... yes, I’d say probably higher than the benefit which we know is going to be very small.”

Peter Kavelaars, director of the academic desk at Deloitte Tax Advisers in Rotterdam, has called Pillar Two “the most complex tax system we know globally”.

Lau pointed to the Inland Revenue Department’s (IRD) own estimates that the local tax change is expected to raise just $24 million extra in annual revenue (an additional $16m in tax is also expected to accrue through reduced profit shifting to low-tax counties, but this is expected regardless of whether New Zealand makes any change). The IRD estimates that only 20 to 25 New Zealand companies will need to report under the new rules.

On the other hand, the agency estimates it will cost $11m to build systems to monitor and administer the tax, and an annual $3m to operate them.

To be fair, Lau said she has sympathy for the New Zealand Government’s position. The nature of the new rules is such that even if Wellington had not adopted them, New Zealand-headquartered multinationals would likely still encounter compliance requirements through their subsidiary entities in other countries, so long as a critical mass of other countries also adopted the measures.

Where the country of an affected multinational’s parent company has not adopted the rules, the home countries of an intermediate holding company can collect the top-up tax (providing those jurisdictions have instituted the rules). There are also several layers of further backstop provisions.

A made-in-America spanner in the works?

Given that the Pillar Two rules have been adopted by a reasonably large number of countries, technically there will be no change if the US does not follow suit, Dean Madsen, EY tax partner based in Auckland, told the Herald.

”However, given how much global commerce involves the US, questions would arise as to how effective the initiative would be without US involvement. For example, this would likely mean a number of countries far smaller than the US – New Zealand among them – potentially collecting additional tax on certain payments destined for the US under Pillar Two. These countries would, I expect, think long and hard about the consequences of doing so, including [about] any trade implications as a result.”

Has Pillar One crumbled?

If Pillar Two rules are in jeopardy, so called “Pillar One” rules appear to be in ruins. This second, and parallel, OECD initiative aims to allocate a portion of behemoth multinationals’ profits – only companies with revenue over €20b ($37b) are in scope – to countries where they have significant sales, even where the company has no related physical presence.

This is aimed especially at digital services companies like Google and Meta – the majority of companies in scope are American.

The Pillar One plan aims to allocate more corporate profit to “market countries”, where actual customers or users live. But it’s currently stalled.

“Consensus on Pillar One is proving more challenging than Pillar Two, with implementation and final structure still unclear. Countries housing large multinationals are hesitant to relinquish tax revenue, complicating negotiations,” Madsen said.

Some countries have unilaterally introduced their own digital services taxes in the meantime – these typically apply to revenue earned by companies from certain digital services.

But the world appears to be moving into an age when it is more economically dangerous than ever to target US companies at the expense of US government coffers. New Zealand has a Digital Services Tax Bill drafted and introduced to Parliament, despite the Ministry of Foreign Affairs’ express warning of trade retaliation. Not coincidentally, the bill has been firmly on hold since the US election.