Many businesses will be aware of the ongoing work of the OECD relating to Base Erosion and Profit Shifting ("BEPS"). The OECD published its first report, entitled Addressing Base Erosion and Profit Shifting in February this year. The next stage in the project is for tax authorities from OECD member countries (which include New Zealand) and participating non-member countries (which include China and India) to develop an action plan for addressing BEPS. This is intended to occur at a meeting of OECD's Committee on Fiscal Affairs in June this year.
New Zealand's response to BEPS will be shaped by the fact we have a small and open economy, with a significant level of foreign direct investment coming from our closest major trading partner, Australia. Reflecting those considerations, the initial advice from Inland Revenue and Treasury to the Government late last year was that New Zealand should adopt a three-pronged approach to BEPS concerns:1
- Contributing to the OECD's BEPS project.
- Reviewing domestic law and prioritising projects that will protect the New Zealand tax base from multinational profit-shifting.
- Coordinating with Australia on Australia's response to these issues.
A recent Tax Policy Report ("April Report") released by Inland Revenue and the Treasury (available here) provides an update on New Zealand's response, and outlines specific initiatives New Zealand will consider to address BEPS concerns.
New Zealand initiatives to combat BEPS
The April Report identifies possible law reform projects for prioritisation as part of New Zealand's response to BEPS. The report also discusses recent announcements made by the Australian Government.
The first possible law reform project identified is the proposed broadening of the thin capitalisation rules. In January this year, Inland Revenue released an issues paper proposing changes which would extend the reach of New Zealand's thin capitalisation rules.2 There are two key objectives of the proposed reforms:
- to broaden the scope of the inbound thin capitalisation rules so they will apply to New Zealand companies owned or controlled by a consortium of foreign investors, as well as to New Zealand companies controlled by a single foreign owner;
- to tighten the rules for calculating the limits on the level of debt and deductible interest expenditure allowable to the New Zealand group.
A full summary of the proposals in respect of thin capitalisation can be found here. Inland Revenue and Treasury have indicated that legislation to implement the thin capitalisation reforms should be introduced in August this year.
The second project identified relates to withholding taxes, and in particular withholding taxes on interest. While still at a research stage, it is understood that a possible concern relates to a timing mismatch between when interest expenditure is deductible to the payer, and when withholding tax becomes payable on the interest. Currently, interest expenditure is deductible on an accrual basis, while withholding tax applies only upon payment. The April Report notes that following further research, a report with potential options to address this concern will be released.3
The April Report also foreshadows a possible review of tax arbitrage opportunities arising from cross-border mismatches in the treatment of hybrid instruments or hybrid entities. That review will be based on OECD work that will consider policy developments in other countries.4
The April Report also highlights the collaboration on BEPS initiatives between Australia and New Zealand, noting the regular contact between New Zealand officials and the Australian Treasury. In particular, the report notes that the Australian Government has recently released a Discussion Paper entitled Improving the transparency of Australia's business tax system (available here). That Discussion Paper seeks comments on three specific proposals in relation to the Australian Tax Office's ("ATO") use of information concerning large taxpayers. The proposals all contemplate a dilution of the ATO's general obligation of secrecy that has traditionally applied to the use of taxpayer specific information. Three specific proposals are:
- That the ATO would publish a list of the names, total income, taxable income and income tax payable of companies with over A$100m of total income. In addition, the ATO would also publish the names of companies that pay the new Minerals Resource Rent Tax or the Petroleum Resource Rent Tax and the amount of these taxes paid.
- A proposal to publish aggregate collections for each type of Australian tax even if this information could be used to deduce tax paid by a particular taxpayer.
- A proposal to enable greater information sharing between the ATO and the Treasury with respect to foreign acquisition and investment decisions affecting Australia.
Although the April Report does not comment on the merit of the Australian proposals, it states that the idea of requiring certain companies to publish certain tax-related information will be discussed further with the relevant Ministers. In addition, the April Report observes that certain foreign-owned businesses operating in New Zealand are already required to publish financial statements in respect of their New Zealand operations, and that the information published will include accounting measures of income tax payable.5 Those financial statement requirements are themselves currently subject to proposed reforms set out in the Financial Reporting Bill which was introduced to Parliament in July 2012 and is expected to be enacted later this year.
New Zealand's response to BEPS has so far been measured and systematic. This reflects the fact that there is already a high level of transparency concerning tax payments by multinationals operating in New Zealand (given requirements that certain companies publish their financial statements) as well as the fact that domestic law already contains provisions limiting opportunities for tax planning, including comprehensive controlled foreign corporation and foreign investment fund regimes and a thin capitalisation and transfer pricing regime. That said, businesses should monitor developments, in particular in respect of thin capitalisation, withholding tax on interest, and anti-arbitrage issues, which are mentioned in the April Report as areas for possible reform.
Businesses should also be aware that New Zealand's general anti-avoidance rule ("GAAR") is now being applied in a broader way than GAARs in most other jurisdictions. In fact, there is a concern that in some cases, the GAAR is being applied in a way that really amounts to retrospective law-making, to address situations in which Inland Revenue encounters gaps in the tax laws which could have been addressed by enacting remedial amendments to the tax laws to address an identified concern. As an example, New Zealand's debt/equity boundary for tax purposes generally follows the legal form of the arrangement, but the GAAR has in some cases been applied to deny interest deductions under hybrid arrangements and shareholder debt, thereby (in effect) denying an interest deduction to a taxpayer that has a business need for the funds borrowed, and has complied with both the thin capitalisation and transfer pricing regimes.6
Experience in New Zealand and in other jurisdictions suggests that Inland Revenue will sooner or later be constrained in its ability to rely on the GAAR, for the simple reason that a GAAR by its nature is so open textured that its application depends on the attitudes of Judges, and on the way particular cases are presented to the Court. But in the meantime, multinationals investing in New Zealand need to be aware that the recent more expansive application of the GAAR is a source of particular uncertainty that needs to be carefully considered, alongside other measures targeting BEPS that may be implemented internationally or specifically in the New Zealand context.