Terry Baucher reviews how the tax authorities have started to move against tax base erosion and profit shifting by multinationals

By Terry Baucher*

2016 was the year tax authorities and other agencies around the world decided multinationals’ international tax planning was, as John Key remarked to Facebook’s Mark Zuckerberg, “not a good look”. 

Beginning with the reaction to the Panama Paper revelations, through to the European Commission ruling that Apple pay the Irish Government €13 billion in unpaid taxes, multinationals’ tax planning was put under pressure.

What was interesting about the Panama Papers was the visceral public reaction. Despite protestations to the contrary from the Prime Minister and Minister of Revenue there was widespread public unease about New Zealand’s involvement.  It was a clear sign the public were growing intolerant of “unfair” and aggressive tax planning.

So far, the Panama Papers have not revealed any evidence of any direct tax avoidance by New Zealand tax residents.  This is probably as it should be since the foreign trust regime was intended to make it very difficult for New Zealand residents to avoid tax through the use of offshore structures. 

Against this backdrop of public discontent, the OECD Base Erosion and Profit Shifting (BEPS) and Automatic Exchange of Information (AEOI) initiatives moved closer to implementation.  These initiatives specifically target aggressive tax planning by multinationals and individuals.  In August, the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Bill introduced enabling legislation to meet New Zealand’s AEOI commitments.  

The Bill also contained the relevant legislation to implement the Shewan report’s recommended enhanced disclosure requirements for foreign trusts.

In September as part of New Zealand’s response to the BEPS initiative, Inland Revenue released the discussion document Addressing hybrid mismatch arrangements.

Hybrid mismatches play a large role in international tax planning.  They exploit the differences between countries in the tax treatment of cross border transactions involving hybrid entities such as limited partnerships or look-through companies. A hybrid mismatch transaction can, for example, create two deductions for one borrowing or create a deduction in one country without corresponding income arising in another country.  The BEPS proposals are intended to eliminate such “double non-taxation”.

The discussion document noted the tax revenue loss caused by the use of hybrids was difficult to estimate but was “significant in the cases that the Government is aware of.” For example, the Alesco case involved approximately $300 million of tax across several years.  The discussion document estimated $80 million in tax revenue was lost each year from known hybrid structures.

The discussion document also contained a hidden bombshell for foreign trusts with a suggestion that foreign trusts were effectively hybrids.  On this basis, New Zealand should therefore tax a foreign trust’s non-New Zealand sourced income.   Unsurprisingly this suggestion has been heavily criticised, partly on the grounds that it is based on an incorrect interpretation of trust law.  The proposal would also overturn one of the conclusions of the Shewan report that the principle of not taxing foreign-sourced income derived by non-residents was “consistent with the coherent set of core principles that underpin New Zealand tax policy”.   

The discussion document’s foreign trust proposals seem to be more a passing afterthought than fully developed policy.  However, they probably reflect political unease in the wake of the Panama Papers.  As a result, they could still become law, a move which would undoubtedly hurt New Zealand’s foreign trust industry.

Aside from hybrid mismatch arrangements, another threat to the tax base is the practice of the likes of Facebook, Google and Uber to use a model based on the theory that they have no taxable presence in New Zealand (or “permanent establishment”). The real economic activity is carried on outside New Zealand. Under this model the local subsidiaries of Facebook, Google and Uber simply provide marketing support in exchange for a fee paid by a related company.  Meantime the fees paid by advertisers on Facebook and Google, or fares by Uber users are paid elsewhere, usually via The Netherlands. 

MasterCard and Visa appear to have adopted a similar model with Singapore acting as the hub. Singapore’s 17% corporation tax rate makes it attractive as a base for multinationals.  Singapore's Economic Development Board is also willing to negotiate tax holidays as it did with both companies and reducing their effective tax rate to under 5%.  Fortunately for MasterCard and Visa there is no Asian equivalent of the European Commission to rule against these arrangements.

Multinationals’ tax planning strategies represent a double whammy for Inland Revenue.  New Zealand businesses incur tax deductible costs such as advertising or credit card fees but there is little matching revenue to tax.  For example, at the company income tax rate of 28% Retail NZ’s estimated annual credit card fees of $373 million represent a deduction of over $100 million.  There’s also the not insignificant issue of advertising revenue heading offshore weakening New Zealand media and journalism.

The recently released Cabinet paper on transfer pricing and permanent establishments discusses possible counter-measures to these practices.

The paper raises the option of following Australia and the United Kingdom and introducing a Diverted Profits Tax (DPT).  A DPT is levied at a penal rate compared with income tax and has greatly enhanced assessment and collection powers.  (For example, Australia’s proposed DPT would have a rate of 40% compared with the regular corporate tax rate of 30%).  The aim of a DPT is not to raise revenue but “incentivise multinationals to pay the correct amount of income tax under the normal rules”. 

The paper rejects introducing a DPT partly out of fear of possible retaliation by other countries.  Instead it suggests combining “certain features of a DPT” with other BEPS measures, giving Inland Revenue additional powers to obtain information and shifting the burden of proof from Inland Revenue to multinationals.  Overall the measures are intended to prevent multinationals arguing they have no permanent establishment in New Zealand.  However, the paper notes the proposals

… would not tax non-resident suppliers without a material physical presence in New Zealand.  Such non-resident suppliers include multinationals that have been the focus of some public concern in New Zealand and internationally.

Does that mean the likes of Apple, Facebook, Google, MasterCard, Uber and Visa may still be outside the New Zealand tax net?  Possibly, and we won’t know until the full details of the proposals are released early next year.  Whatever, it will be another step in what will be an ongoing struggle between the tax planners and Inland Revenue.  

This is my final column for the year. I'd like to thank David Chaston and Gareth Vaughan for continuing to let me ramble on about tax throughout the year. A big thank you also to the many readers who commented on or emailed me about an article. I trust you all had a very Merry Christmas and best wishes for a Happy New Year.

*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »