Countering concerns about multinationals paying their 'fair share' of tax

Opinion

We should congratulate the government for listening to concerns that some non-resident multinationals are not paying their fair share of tax. This has been a big deal in other countries and it is also been a significant issue in this country. Earlier this year it was suggested in an investigation carried out by Herald reporter Matt Nippert that 20 multinational companies operating in New Zealand were paying tax of $1.8 million on revenue of $10 billion. Some of these huge companies have been using strategies which allow them to report low taxable profits in New Zealand (and elsewhere).

The recent Cabinet paper suggests that in early 2017 a new government discussion document will be released suggesting the possible introduction of a tailored package designed especially for the New Zealand tax environment.

So what exactly is the problem? Now it seems obvious that double tax treaties are designed to prevent or reduce double taxation. International business is greatly encouraged to undertake cross-border transactions where there is only one level of taxation rather than experiencing double taxation.

Where a multinational is resident in one country (the country of residence taxation) and does business in another (the country of source taxation) the international norm has been to not impose tax in the country of source unless there is a sufficient physical or contractual nexus (or connection) to constitute a so-called "permanent establishment".

Intentionally, and by design, New Zealand has therefore entered into double tax agreements designed to limit the ability of New Zealand to tax New Zealand sourced business profits in circumstances where the foreign multinational does not operate a "permanent establishment" in New Zealand. Generally speaking, this policy has been eminently sensible in the past and it has served us well for a long period of time but it does assume that the country of residence imposes a tax. Furthermore, the concept of permanent establishment has not kept pace with technological advancement and the digital age. Multinationals have been more nimble than governments and have sometimes been able to structure their affairs so that they have enjoyed double non-taxation.

Some multinationals have therefore been operating their business here without triggering a tax liability because they have been, legally, stepping around the taxation of business profits by making sure they do not have a permanent establishment in this country. Other aggressive multinationals enter into arrangements with related parties that reduce their taxable profits in New Zealand through transfer pricing avoidance techniques.

To counter this type of activity some countries such as the UK and Australia have deliberately imposed (or are imposing) a new and separate tax known as a diverted profits tax (DPT). The NZ discussion document does not go this far as to suggest a DPT but it borrows some features from our common law neighbours and allies.

Key features of the New Zealand package, to be released in the discussion document, will be special rules designed to prevent aspects of double tax agreements being abused. In particular, it will discuss the introduction of measures to prevent the avoidance of permanent establishment in New Zealand.

In addition, it is proposed that there is amendments to our transfer pricing legislation to enable the collection of more (and better) information with the objective of taxing multinationals more in accordance with the economic substance of the activities that they are carrying on in this jurisdiction. Another change for the transfer pricing rules is the transfer of the burden of proof to the taxpayer from the Crown.

Is this a welcome development? Yes, I think so. It is targeted, not at the normal business structure, but at a minority of multinationals who are operating here in New Zealand and engage in aggressive tax practices. While the government (and their officials) has not ruled out the possibility of a DVP the current proposal does not immediately embrace such unilateral action of a new tax and instead suggests a reform which is less structurally damaging to our tax infrastructure whilst giving tools to the revenue to pursue aggressive multinational structures.

The hope is that our multinationals selling products in a foreign jurisdiction are operating within more conventional and less aggressive structures so that reciprocal taxation does not occur in that foreign state. New Zealand corporates and their advisers will be concerned about overreach and the consequence of other countries acting unilaterally to tax their foreign sourced earnings. The key to the new rules is that they are fairly and squarely anti-avoidance provisions.

Overall it is clearly desirable that taxation is borne by entities that are involved in significant economic activity here in New Zealand and they clearly should not be allowed to reduce their taxable profits with arrangements with associated parties that lack economic substance.

Such developments in tax policy provide greater confidence for ordinary New Zealanders in the integrity of the tax system. This was not the original response by the government to this problem earlier this year. It was suggested that all solutions could be found in the OECD base erosion and profit shifting plan (BEPS). To return to my original comment: credit should be given to the government for listening and reconsidering.

Professor Craig Elliffe if a professor of tax law in the Faculty of Law at the University of Auckland.