Let’s talk about tax.
Or more particularly let’s talk about the taxation of US citizens living abroad.
I just love the Royal Family. Yeah I know it goes against any and every possible progressive and egalitarian ideal I hold but phish.
I grew up reading my grandmother’s Women’s Weekly and their coverage of Princess Anne’s (first) wedding and the Silver Jubilee. Over time this progressed to Diana, Fergie and their babies. And the Womens Weekly became the Hello magazine. Complete with Princess Beatrice aged two at a society wedding. So good.
And season two of The Crown has landed. Brilliant. I mean seriously- what about Philip?
Of course season one was dominated by the spectre of the abdication of a King who wanted to marry a divorced American woman. As well as the sister of the Queen who wanted to marry a divorced man.
So it was with every sense of delighted irony that I watched the recent engagement of Prince Harry to a divorced older mixed race American woman. Whose father might be catholic. ROFLMAO.
And my delight became complete when the Washington Post pointed out Meghan and Harry’s children will be subject to FATCA and US residence taxation. Oh and I have been meaning to write about the joys of US citizen taxation since like forever. So finally here was my angle.
The British Royal family – the gift that keeps on giving.
First key thing is that all people born in the United States or born to at least one US parent – like Harry’s children will be – are US citizens. And at this point such people who don’t live in America can get a little over excited. I can work in America woohoo. No green card or resident alien stuff for me! Transiting through LAX will be a breeze.
All true. But much like the British Royal Family – US citizenship is also the gift that keeps on giving.
Now dear readers we have covered tax residence of individuals before. The tests that determine whether a country can tax on the foreign income of its inhabitants. And most countries have some version of the being here or owning stuff rule to work out whether someone is tax resident.
But thanks to American exceptionalism they go one step further. The US applies residence taxation to its citizens even the ones who don’t live there. So with foreign income and US citizens it is now possible to have the country of the source of the income, the country of ‘main’ residence and the US in the mix. So for Harry’s kids: with that Bermuda dosh: there could be Bermuda; United Kingdom and the United States all with their hand out. Just as well Bermuda not big on taxation. Such a relief. That is if Hazza pays tax in the first place.
Now for lesser New Zealand mortals who might be born in the US or have a Meghan Markle equivalent mum or dad: the US/NZ tax treaty is kinda important. And if they have income from any other country that country’s US treaty will also be your friend.
Because in all those treaties is a nifty little clause called Relief of Double Taxation. Aka such a relief – no double taxation. So let’s look a a situation where a New Zealand tax resident with a US born mum – NZUSM – earns $100 Australian interest income. Australia will deduct 10% tax or $10. New Zealand will also tax that income and another $23 ($33-$10) tax will be paid in New Zealand.
Then – because who doesn’t love a party – so will the United States. Giving an Australian tax credit of $10 and a New Zealand tax credit of $23. Depending on the US tax rate for the NZUSM – they will have to pay more tax; pay no more tax; or get surplus credits to carry forward.
Now for something like interest or any other income source New Zealand taxes; this is just annoying. Maybe a bit more tax to pay but not the end of the world.
The full horror comes when NZUSM has types of income that the US taxes but NZ doesn’t. You know like capital gains? Taxable in the US. And the horror becomes squared when NZUSM realises that the US uses its – not NZ’s – tax rules and classifications to calculate the income. Who would have thought?
So that look through company or loss attributing qualifying company where income has been taxed in hands of shareholders – treated as company the US – maybe not so clever after all. Coz what about a LTC loss that was offset against the taxable income of NZUSM – coz it is all like the same economic owner? US – no loss offset allowed – full tax now due. In the US the LTC is discrete NZ company. Nothing to do with NZUSM.
And then of course there is FATCA. For like ever the US has a requirement that its foreign based citizens report their balances with foreign banks. Now quelle surprise – compliance wasn’t great. So the US then said they would collect the information from the foreign banks directly and if they didn’t comply they’d impose a 30% tax on fund flows from the US. Did concentrate the mind somewhat.
Now the US is using this information to enforce compliance. And the NZUSMs of the world are not best pleased. Finding out there was a dark side – albeit one pretty well known – to the whole I can work in the US thing. Unsurprisingly there is a wave of people seeking to renounce their citizenship. Alg except the tax thing goes on for ten years after such renunciation. And such renunciation can’t be done by parents for their children.
So while Harry may have finally found his bride; he has also found the US tax system. What could possibly go wrong?
Let’s talk about tax.
Or more particularly let’s talk about accounting tax expense.
Now dear readers the most unlikely thing has happened. A tax free week in the media. No Matt Nippert on charities – just for the moment I hope – no Greens on foreign trusts. No negative gearing and – thankfully – no R&D tax credits. So with nothing topical atm – we can return to actually useful and non-reactive posts. And yes I am the arbiter of this. Although the whole Roger Douglas and his #taxesaregross does warrant a chat. Need to psyche into that a bit first though.
So I am now returning to my guilt list. Things I have been asked to write about but haven’t . That list includes land tax; estate duties; some GST things; raising company tax rate; minimum taxes; and accounting tax expense.
And so today picking from the random number generator that is my inclination – you get accounting tax expense.
At the Revenue when reviewing accounts one of the things that gets looked at is the actual tax paid compared to the accounting income. This percentage gives what is known as the effective tax rate or ETR. And yes there are differences in income and expense recognition between accounting and tax but for vanilla businesses – in practice – not as many as you would think.
Now it is true that a low ETR can at times be easily explained through untaxed foreign income or unrealised capital profits. But it is also true that for potential audits it can be a reasonable first step in working out if something is ‘wrong’. Coz like it was how the Banks tax avoidance was found. They had ETRs of like 6% or so when the statutory rate was 33%.
So when I ran into a May EY report that said foreign multinationals operating in New Zealand had ETRs around the statutory rate – I was intrigued.
Looking at it a bit more – it was clear that it was a comparison of the accounting tax expense and the accounting income. Not the actual tax paid and accounting income. Now nothing actually wrong with that comparison but possibly also not super clear cut that all is well in tax land.
And I have been promising/threatening to do a post on the difference between these two. So with nothing actually topical – aka interesting – happening this week; now looks good.
Now the first thing to note is that the tax expense in the accounts is a function of the accounting profit. So if like Facebook NZ income is arguably booked in Ireland – then as it isn’t in the revenues; it won’t be in the profits and so won’t be in the tax expense.
Second thing to note is that the purpose of the accounts is to show how the performance of the company in a year; what assets are owned and how they are funded. One key section of the accounts called Equity or Shareholders funds which shows how much of the company’s assets belong to the shareholders.
And the accounts are primarily prepared for the shareholders so they know how much of the company’s assets belong to them. Yeah banks and other peeps – such as nosey commentators – can be interested too but the accounts are still framed around analysing how the company/shareholders have made their money.
And it is in this context that the tax expense is calculated. It aims to deduct from the profit – that would otherwise increase the amount belonging to shareholders – any amount of value that will go to the consolidated fund at some stage. Worth repeating – at some stage.
First a disclaimer. When IFRS came in mid 2000s the tax accounting rules moved from really quite difficult to insanely hard and at times quite nuts. Silly is another technical term. That is they moved from an income statement to a balance sheet approach. Now because I am quite kind the rest of the post will describe the income statement approach which should give you the guts of the idea as to why they are different. Don’t try passing any exams on it though.
Now the way it is calculated is to first apply the statutory rate to the accounting profit. And it is the statutory rate of the country concerned. That is why it was a dead give away with Apple – note 16 – that they weren’t paying tax here even though they were a NZ incorporated company. The statutory rate they used was Australia’s.
Then the next step is to look for things called ‘permanent differences’. That is bits of the profit calculation that are completely outside the income tax calculation. Active foreign income from subsidiaries; capital gains and now building depreciation are but three examples. So then the tax effect of that is then deducted (or added) from the original calculation.
For Ryman – note 4 – adjusting for non-taxable income takes their tax expense from from $309 million to $3.9 million. That number then becomes the tax expense for accounting.
But there is still a bunch of stuff where the tax treatment is different:
- Interest is fully tax deductible for a company. But – if that cost is part of an asset – it is added to the cost of the asset and then depreciated for accounting. And the depreciation will cause a reduction in the profits over say – if a building – 40-50 years. So for tax interest reduces taxable profit immediately while for accounting 1/50th of it reduces accounting profits over the next 50 years.
- Replacements to parts of buildings that aren’t depreciable for tax can – like interest – receive an immediate tax deduction. But for accounting a new roof or hot water tank are added to the depreciable cost of the building and written off over the life of the asset.
- Dodgy debts from customers work the other way. Accounting takes an expense when they are merely doubtful. But for tax they have to actually be bad before they can be a tax deduction.
These things used to be known as timing differences as it was just timing between when tax and accounting recognised the expense.
And then the difference between the actual cash tax and the tax expense becomes a deferred tax asset or liability. It is an asset where more tax has been paid than the accounting expense and a liability where less tax has been paid than the expense.
And the fact that these two numbers are different does not mean anyone is being deceptive. They just have different raisons d’etre. Now if anyone wants to know how much actual tax is paid – the best places to look are the imputation account or the cash flow statement. The actual cash tax lurks in those places.
But yeah it does look like actual tax. I mean it is called tax expense.
Your correspondent has memories of the public comment when the banking cases started to leak out. I still remember one morning making breakfasts and school lunches when on Morning Report some very important banking commentator was talking. He was saying that the cases seemed surprising coz looking at the accounts the tax expense ratio seemed to be 30%. [33% stat rate at the time]. But that 3% of the accounting profits was still a large number and so possibly worthy of IRD activity.
Dude – no one would have been going after a 3% difference.
In those cases conduit tax relief on foreign income was being claimed on which NRWT was theoretically due if that foreign income were ever paid out. So because of this the tax relief being claimed never showed up in the accounts as it was like always just timing.
Except that the wheeze was there was no actual foreign income. It was all just rebadged NZ income. And yeah that income might be paid out sometime while the bank was a going concern. So it stayed as part of the tax expense. Serindipitously giving a 30% accounting effective tax rate while the actual tax effective tax rate was 6%.
And a lot of these issues are acknowledged by EY on page 13 of under ‘pitfalls’.
So yeah foreign multinationals – like their domestic counterparts – may well have accounting tax expense ratios of 28%. But whether anyone is paying their fair share though – only Inland Revenue will know.
Let’s talk about tax.
Or more particularly let’s talk about the tax rules for deregistering charities.
It has been a big intellectual week for your correspondent. Tuesday night White Man Behind a Desk. No tax. An interesting riff on immigration that Michael Reddell clearly wasn’t the tech checker for. Wednesday night Aphra Green Harkness Fellow on US criminal justice reform coz States just ran out of money. Tried to run an argument that this was the good side of low taxes. Didn’t resonate – go figure. And Wednesday morning – Roger Douglas on turning taxes into savings coz #taxesaregross.
And it was on the lovely Roger I planning to write but on Friday was the Greens on how there were bugg@r all foreign trusts reregistering. So I thought I’d write about that and the genius decision to require disclosure rather than taxation.
And as if that wasn’t enough. Saturday morning the latest Matt Nippert on a US and charities thing. An elderly couple with no heirs wanting to transfer wealth to a charitable institution – awh lovely. So nice they chose NZ. But also Panama, low distributions and references to the IRS. Ok. Initial reaction was it looks like FATCA avoidance coz NZ charities are outside its scope of reporting to IRS. Really must get on to my ‘US citizenship is not a good thing for tax’ post. It has been in the can for longer than this blog has been running. So embarrassed.
But one thing really caught my eye. The charities had voluntarily deregistered. Mmm interesting.
Your correspondent now moves a tiny bit in the Charities NGO sector. And from time to time I hear ‘should we stay a charity? Coz need to be careful over advocacy and ActionStation isn’t a charity and it is alg for them.’
To which I try to reply in my best talking to Ministers language: ‘ That’s one option. It would mean handing over a third of your reserves in taxes or all of your reserves to another registered charity. But totes – if that is what you want.’
Strangely the conversation doesn’t continue.
Coz the law changed in 2014 to stop the rort of charities getting lots of lovely tax subsidised donations, not distributing; deregistering and then keeping all that lovely taxpayer dosh for themselves. Go Hon Todd!
Now on the face of it this should apply to our friends here very soon. Section HR 12 applies a year after deregistration and turns the reserves – less wot go to another charity – into taxable income.
Except there doesn’t seem to be anything explicit that makes it New Zealand source income. Possibly personal property or maybe indirectly sourced from New Zealand. But the source rules are kind of old school and want to bite on real stuff not deemed income. No matter how worthy of New Zealand source taxing rights it should be.
And of course none of this matters dear readers if the entity is New Zealand resident. Coz everything gets taxed! And as the trustees are a New Zealand company – high chance it will be. So alg.
Coz if the dosh in the charity all came completely from non-residents – the trust rules make it a foreign trust. And foreign source income aka income wot doesn’t have a New Zealand source is not taxed. So initial view – unless the source rules can bite on this deemed income or the trust isn’t a foreign one – there will be no wash up for our friends here.
Now on one level that is cool. The final tax was all about clawing back the tax benefits given on the initial donations and the charitable tax exemption on income. Here it would have been tax exempt anyway. So alg.
The other argument is that these guys intentionally registered as a New Zealand charity. Got all the good stuff like potentially non- disclosure to IRS as well as being to say they are a legit NZ charity. But now don’t get the bad stuff.
And NZ gets the bad name but not the income. What does that sound like? Oh yes the NZ Foreign Trust rules.
So glad that – according to the Greens – is coming to an end. Shame it had to be such a resource intensive way of doing it.
Let’s talk about tax.
Or more particularly let’s talk about the recent Australian transfer pricing case Chevron.
In a week when Inland Revenue announced a major restructure which will involve staff now needing ‘broad skill ranges’; it made me think of the type of work I used to do there – international tax.
It was true that my job needed skills other than technical ones:
- keeping your cool when being verbally attacked by the other side;
- being able to explain technical stuff to people ‘who don’t know anything about tax’ – aka anyone at Inland Revenue not in a direct tax technical function;
- ensuring the bright young ones got opportunities and didn’t get lost in the system; and
- generally ‘leveraging’ my networks to support those who were doing cutting edge stuff but not getting cut through doing things the ‘right’ way.
But otherwise what I did required a quite narrow specialised technical skill range. And that was good as it allowed me and my colleagues to focus on one particular area so we could be credible and effective. You know kinda like professional firms do?
As an aside I am not sure how this broad skill ranges thing ties in with the original business case – page 36 – which alluded to the workforce becoming more knowledge based. Coz knowledge-based work is kinda specialised not broad. But then the proposals are coming from a Commissioner who has a legal obligation to protect both the integrity of the tax system as well as the medium to long term sustainability of the department so I am sure she knows what she is doing.
Wonder what the penalties are for breaching those provisions? But I digress.
Back to me. The international tax I did though was actually quite broad compared to the work my colleagues did in transfer pricing. That was eye wateringly specialised and quite rightly so. These were the girls and boys who were on the frontline with the real multinationals like Apple, Google, Uber and the like.
The guts of the case is that Chevron Australia set up a subsidiary in the US which borrowed money from third parties for – let us say – not very much and on lent it to Chevron Australia for – let us say – loads. And it was with a facility of 2.5 billion US dollars. Now you can kinda imagine the difference between not very much and loads on that was a f$cktonne of interest deductions – see why I get obsessed with interest – and therefore profit shifting from Australia to the US.
Now even though it was a subsidiary of Chevron Australia; the Australian CFC rules don’t seem to apply to the US. Coz comparatively taxed country – thank god we don’t have those rules anymore. And the judgment says it wasn’t taxed in the US either. Didn’t spell out why but I am guessing as the Australian companies are Pty ones – check the box stuff – they get grouped in the US somehow. No biggie for US but bucket loads less tax than they would otherwise pay in Australia.
And according to Chevron it was like totes legit. Coz loads is the market price for lots of really risky unsecured debt. I mean seriously dude like look up finance theory.
To which the seriously unbroad people in the Australian Tax Office said – yeah nah. Theory is like only part of it. The test is what would happen with an independent party in that situation.
- Option one – the seriously risky party ponies up with guarantees from those who aren’t seriously risky. You know how those millennials who buy houses and don’t eat smashed avocado do when their parents guarantee their loans? It is the same with big multinationals.
- Option two – banks don’t lend. So just like for all the milennials who don’t own houses but who do eat smashed avocado and don’t have rich parents.
And the Australian court thought about it all – pointed at the unbroad public servants – and said:
“What they said. Chevron you are talking b%llcocks. The arms length price is one an independent party like millennials would actually pay. This includes guarantees and you price on those facts. Not the fantasy nonsense you are spouting.”
Well broadly. Actual wording may vary. Read the judgments.
Now these are seriously useful judgments – internationally – for the whole multinationals paying their fair share thing. Let’s just hope New Zealand keeps the people who can apply them.
Let’s talk about tax. Yes dear readers – tax. No prison reform no yoga stuff. Just nice emotionally simple tax.
Or more particularly let’s talk about the recent Australian Budget announcement of a levy on banks aka the Great Australian Bank Robbery.
Your correspondent has now completed her yoga teacher training and so is available for weddings, funerals and bar/bat mischvahs. Highlights of the course included injuring herself while dancing and getting zero on the first attempt on the final exam.
It’s not like I haven’t failed things before but when the question was – reminiscent of the Peter Cook coal miners sketch – ‘who am I?‘ to fail – mmm – more than a little surreal. Now even the first time thought I had answered in a sufficiently right brained way – lots of introspective emotion involving personal power and connection with others – aahhh no.
But your correspondent is a resilient adaptive individual – even before the course – so regrouped with – ‘complete‘.
I couldn’t make this up. Subsequently found other correct answers included: me; enough – and my particular favourite – light. Ok right. Thanks for sharing.
And it all really did make me crave balance. Which in my world after eight full days on yoga is the left-brained world of tax. I had planned to write about the Australian transfer pricing case Chevron but this week has been the Australian Budget with a big new tax on their banks. And as I have had a few questions on this and I am trying to be more topical – here we go:
Now the bank tax thing seems to be part of a package of the Australian government responding to the Australian banks bad – but probs more likely monopolistic – behaviour. Also potentially a political response to appointing a popular Labour Premier – and good god a woman – to be head of the Bankers Association. And my word the banks must have been bad as they only found out about it on Budget Day and it starts on 1 July without – as far as I can see – any grandfathering.
Wow. Just wow.
So what is it?
It is a levy on big banks liabilities that aren’t:
- customer deposits or
- (tier 1) equity that doesn’t generate a tax deduction.
It targets commercial bonds, hybrid instruments (tier 2 capital) and other instruments that smaller banks can’t access coz they are small. And as it will form part of the cost of this borrowing- under normal tax principles – the levy would be tax deductible. But even allowing for this tax deduction it is supposed to raise AUD 6.2 billion over four years. So not chump change.
What is its effect?
Now there can be no argument that the levy will effectively make such instruments more expensive to use. And here the public arguments get really sophisticated:
- Malcolm Turnbull says that ‘other countries have them’ and it would be ‘unwise’ for banks to pass it on to borrowers; and
- the Treasurer Scott Morrison (ScoMo) is telling banks to ‘cry me a river’ when they have expressed a degree of displeasure.
Awesome. Thanks for playing.
Now while this is predicted to raise revenue; it is by no means clear that this is its primary objective or even if it will occur. The reason being it only applies to big banks and to certain types of liabilities. To me this looks like a form of corrective tax like cigarette excise rather than a revenue raiser like an income or consumption tax like GST.
And much like a tax on cigarettes; pollution or congestion; this tax is 100% avoidable – legitimate tax avoidance even – by funding lending with an untaxed option like customer deposits. In theory anyway. It is likely that banks will have maxxed out how much they can borrow from the public at existing interest rates.
But with this extra tax; the relativities will change. Meaning there is now scope to pay more for the untaxed deposits but less than the tax if Banks want to maintain the same level of lending. Bank costs will still go up but through marginally higher deposit rates incentivised through the tax – rather than the tax itself.
In this scenario the Australian government still gets the costs of the higher interest deduction but not the revenue. But Australian savers win.
As the big banks are the dominant players in the market – this increase in interest rates for depositors will also impact the smaller banks as they will need to pay the higher rates to continue to attract depositors too. So no actual competitive pressure from the small banks and possibly less actual tax. Genius.
An alternative equally revenue enhancing scenario is that banks wind down assets – lending – and become smaller. Less lending but higher cost of borrowing if demand stays the same.
Who bears the cost?
As they do in New Zealand anytime extra taxes are mooted; the Australian banks are arguing that these extra costs will be borne by borrowers. Now in a fully competitive market without barriers to entry the more price dependent – or elastic – the demand for loans is the more it will fall on the shareholders. But lending overall will fall with the imposition of a tax which in turn will have housing market impacts if fewer people can get a mortgage.
With barriers to entry – like hypothetically say banking regulation – they are already pricing to maximise their profit so I would be inclined to say it will also hit shareholders. And the fall in price of banking shares would indicate that is what shareholders think too.
Except that if deposit rates go up instead; the cost structure of the entire banking industry will go up. And if no tax is actually being paid but the cost is being transferred through higher deposit rates then the banking industry will have political cover to pass the cost on to borrowers.
Now if this schmoozle is all about the banks paying more tax then either a higher company tax rate on big banks or increasing the requirements for non- interest bearing capital would have been far simpler. While the former is pretty transparent that it is a blatant tax grab from the banks; the latter less so. They both have the advantage though of ensuring tax can’t be opted out of as well as keeping the competitive pressure from the smaller banks.
But both would form part of the banks cost structure and so – depending on the pressure from the small banks and how elastic demand is – be passed on in some form to borrowers. However if the government really wanted only the shareholders to pay then a one- off windfall tax would be the way to do it.
Whether or not the banks – and their shareholders – should actually be treated like this is another story. But Cry me a river ScoMo: at least be transparent and do it properly!
It goes without saying that this is truly cr@p process. All the detail seems to be in ScoMo’s press statement. Although – legislation by press statement – is an unfortunate feature of Australian tax policy.
And as for the Malcolm Turnbull ‘other countries have it too’ argument. From what I can see this was to pay back the government for the bail outs they gave the banks over the GFC. While Australia does have deposit insurance I wasn’t aware of any like actual bailouts.
It is though kinda reminiscent of the diverted profits tax which is also a targetted tax on a group of bad people. Except that might have a non-negative tax effect. Here we have – to extent it is passed on in higher deposit rates – higher costs industry wide causing less, not more, tax paid by this industry. Let’s just hope for Australia’s sake the savers are not all in the tax free threshold.
So nicely done ScoMo and Big Malc. Possibly more Lavender Hill mob than Ronnie Biggs. But much like the Australian fruit fly; keep it on your side on the Tasman. It makes even this revenue protective commentator blanch and our banking tax base can so do without it.
A commentator on the blog’s facebook page has suggested that this levy makes sense in terms of addressing the huge implicit subsidy that is the Australian deposit guarantee scheme. I have absolutely no issue with this being charged for in the form of a levy on the banks. Naively I would have thought that such a levy would then be based on the deposits covered by the guarantee not the liabilities that aren’t. Apparently that’s not how Australian politics works!
The discussion can be found in the Facebook comments section for this post.
Let’s talk about tax.
Or more particularly let’s talk about the fairness v efficiency tension in tax policy.
You correspondent is now about two thirds through her gap year. There have been perks to not going to work. Meeting people I would never have met as a tax bureaucrat; working without getting out of bed; and morning yoga classes now being conceptually possible. And of course becoming your correspondent tops it out.
On the con side though is no income; a carefully curated wardrobe that just looks at me; and that not going to (paid) work is simply exhausting. I am the most demanding person I have ever worked for. There is no concept of downtime.
Another con as a chartered accountant is there is no benevolent employer meeting my training needs – and my CPD hours – without me realising it. So with this in mind earlier this year I arranged to attend – without credit – a postgrad course on International Tax. Two days which should sort out my CPD. Or at least push out the problem for another year. And after all those years in tax I know the benefit of deferral.
Now as a participant I need to give a talk. So I heroically offered to talk about the tension between the tax fairness people and the tax efficiency people. As at that time I thought I had reconciled them. Now not so sure. So I thought I’d riff to you dear readers and see how we go.
It is an internal discussion I regularly have – yes I really am that interesting. As in my heart I am a tax fairness person but one whose head worries about tax efficiency.
Let’s start with the wot these guys say:
Fairness people say: Everyone should pay their fair share; People should pay in proportion to their income; Tax is the price you pay for civilisation.
And Gareth has a nice general take on all this which can be paraphrased as an unfair economy is inefficient. But while I am quite attracted to that as I can’t explain it without hand waving – I won’t.
So going back to things I do understand.
Efficiency people say: New Zealand needs be an attractive place to invest; it is important tax doesn’t distort decisionmaking; company tax is a tax on labour.
Now in a domestic setting – New Zealanders using New Zealand capital employing New Zealanders; through the use of withholding taxes and imputation – efficiency and fairness cohabit happily. Wages are deductible by firms and taxable to employees. Tax is deducted by the employers on the wages and this offsets the tax liability of the employee. Company tax can be used as a credit when dividends are paid.
There is a progressive tax scale for individuals which applies no matter how they earn their income. There can be deferral benefits if money stays in a company; a concessionary PIE rate for top income earners; and interest is deductible when capital gains are earned. But all of this is cohabitation peace and harmony compared to the situation with foreign capital and New Zealand workers.
Now with foreign capital, tax paid here is next to worthless. The fairness argument is that it is that the tax is the price for using the infrastructure and educated workforce paid for from taxation. Reasonable argument but problem is that the use of that stuff is not conditional on paying tax. Classic public good/freerider thing in economics which is supposed to be stopped through the use of taxation. Mmmm.
And foreign countries give no credit for company tax paid here. They might give credit for withholding taxes but there is this whole ‘excess foreign tax credit thing’ that means they don’t. For serious tax nerds, yes there is the underlying foreign tax credit given by the US when dividends come back. But we all know how much they come back. So foreign tax is a net cost of doing business. And like all costs something they will minimise if they can.
This becomes all the more compounded when the foreign investor is a charity or pension fund or sovereign wealth fund and doesn’t pay even tax in their home country.
So then the options are invest through deductible debt or pay tax but only invest if expected return is high enough to allow for paying tax.
Right. Then so how do we get the price of civilisation thing actually paid? Working on the assumption that foreign investment is good – when I think the analysis is a bit more nuanced than that – do we just have to suck up lower foreign investment if we want more tax paid?
If only we had some New Zealand based studies to see what happened? Oh yeah we do. Company tax was cut once by Dr Cullen and then again by Hon Bill.
Did we see an uptick in foreign investment? Nah – according to Inland Revenue foreign investment as a percentage of gross domestic product pretty much didn’t change.
Now of course there is a lot of noise in that; not the least that it happened over the GFC where normal rules did not apply. And Inland Revenue did have a go at reconciling all the stuff. Maybe.
But the best expanation I ever got for tax and how it influences foreign investment came from a tax mergers and acquisitions person I met during my time inside. They said there are two types of foreign investment:
- Normal foreign businesses who are looking to buy an equivalent New Zealand business. They make their decisons to purchase based on the headline tax rate and say the headline thin capitalisation ratios. Once that decison is make the tax people then swing in and look to minimise the tax further.
- The second type was the private equity lot for whom minimising tax was very much part of their MO. They turn up with elaborate templates – which include tax savings – which then all fed into the decision to purchase and at what price.
Is this right? Dunno but it has always made sense to me. And helps explain the often ‘inconclusive results’ found when two sets of behaviours are blended in any data set.
Ok so what does all of this mean to tax fairness people? I think what it means is be aware that the zero tax rate of significant international investors combined with the internationally lighter taxation of income from capital – none of which is addressed in the OECD BEPS project – mean that getting tax off foreigners may bounce back on locals in the form of higher prices or reduced investment.
To the tax efficiency people though – settle down – any impact is not one for one. The Inland Revenue stuff does show that there is a degree of taxation that is just sucked up by the owners of capital. Coz ultimately all business income comes from people who can get a bit p!ssed if they think you are free riding on their taxes paid infrastructure. And maybe they’ll spend their money somewhere else. Assuming of course that there is a taxpaying alternative coz it’s not like domestic capital is free from loopholes.
So will I say all this in my talk this week? Dunno but thanks for the chat dear readers. My head is clearer now. Thanks for listening.
Let’s talk about tax.
Or more particularly let’s talk about Facebook and their tax payments.
The methadone programme that is this blog is working pretty well and I now have an awful lot of non blog commitments these days. So until after the Budget I will just post when I can rather than every Monday. So those of you who haven’t already – you might like to sign up to email notifications on the right of the screen. Coz dear readers I would hate for you all to miss anything I had to say.
As a further aside I am also open to topic suggestions firstname.lastname@example.org altho I give no guarantee as to when they may turn up.
Now after dealing with Apple, family stuff and Sydney last week; dear readers I was and am a little tired. So as a bit of lite relief after all the nasty multinationals stuff I thought I’d finish off a post on GST I have had in the can for far too long. A reader asked for it last year but it keeps getting crowded out. Soz J.
But then this morning on my feed was a news item on Facebook and how they have very little income or tax paid in New Zealand. And how everyone who gets advertising in NZ contracts with Ireland. And they have very few staff here but earn all this money. But it’s not in their accounts.
Ok right. GST post down you go and Facebook here we come.
Now I have said a number of times there are many and varied ways of not paying tax. Apple uses a wheeze where they give the appearance of being a NZ company but because they are really an Australian company with no physical presence here they don’t pay tax here.
Looking at the 2014 accounts of Facebook New Zealand Limited and the news item Facebook’s wheeze seems to be separating out the income earning process so only some of it sticks in the New Zealand tax base.
Again once upon a time businesses advertised in newspapers or magazines that were physically based here. They would also have had a sales force that would have been a department of the newspaper or magazine probs also based in the same building as the publication.
The New Zealand company
Now the newspaper or website is in the cloud which just means a server somewhere. But there is still a sales force – or at least a sales support force – based in New Zealand. These guys are employed by Facebook New Zealand Limited a NZ incorporated company that earns fees from for its sales supporting.
Now a NZ incorporated company as you know dear readers this is prima facie taxable on all its income as it is tax resident in NZ. Ah you say but ‘what about the directors? Where is the control?’ Well done dear readers yes there are three foreign directors . Sigh. An Australian, an Irishman and a Singaporean. Beginnings of a bad joke. But good news is probs hard to show control in any one country.
So probably still resident under a treaty in New Zealand. And even if it isn’t as the sales support income is being earned from a physical presence here – note 7 shows office equipment – so probably fully taxable here. But expressions involving small mercies are coming to mind – it is only sales support income. But should be at armslength rates – usually done as a markup on cost. So there should always be taxable income here even if it is small.
The Irish company
And in the old days not only would the sales force be in NZ, the advertising contracts would be made with a NZ company. Not now. The Stuff article shows advertising agreements being made with a sister company in Ireland – Facebook Ireland Limited. This is also referenced in note 13 of the 2014 accounts so it must be true.
Now it is conceptually possible that Facebook Ireland Ltd is a NZ resident company if it had NZ directors – please stop laughing – but I am going to assume it isn’t. So let’s do the source rule thing.
Trading in v trading with
By now dear readers you will be quite expert on the whole trading in versus trading with thing. If there were no people here I would have said that this was trading with again. However the people on the ground – albeit employed by the NZ company – complicate the issue and what with the possibility that the contracts are partially completed in New Zealand. Hey I am going to give it a New Zealand source!
Limits of the permanent establishment rules
But then we go to the Irish treaty. Now the normal fixed place of business stuff can’t apply as it is Facebook NZ not Facebook Ireland that has the fixed place of business. However Article 5(5) provides that if another company – Facebook NZ – habitually enters into contracts for Facebook Ireland then game on – PE.
However your correspondent being the somewhat cynical – I have always preferred realist – individual she is is guessing the line is: ‘Dude they don’t conclude contracts for us – they are just like sales support – you know like preparatory and auxiliary. All the like real commercial work is done in Ireland not New Zealand – so bog off Mrs Commissioner.’
Yeah that is a bit clever and yeah that is what the tax avoidance provisons are for. And we can’t assume that the Department isn’t trying to use them.
Diverted Profits Tax – NZ style
Now PE avoidance is exactly how this all appears to your correspondent and that is what the government’s proposals are trying to counter. So lets see how that goes. Tests are:
Second point check – Facebook NZ does sales support;
Third point check – seems unlikely that only $1million was sales revenue in 2014
Fourth point – Ah.
The Irish treaty was concluded in 1988 long before BEPS; the international tax rules were only just coming in; and the Commissioner engaged in trench warfare that became the basis of the Winebox. Number 4 might be a bit of a struggle.
This struggle is alluded to in the discussion document’s technical appendix. Apple is example 1 and Facebook example 3. Example 3 discusses the application of the DPT NZ style and says it really is only any good if new treaties get new PE articles. And then says that maybe some countries won’t want them. Let’s all take an educated guess what Ireland will think.
But don’t panic. The OECD is doing some work on this which should come out in 2020. Awesome but wasn’t this exacly what Action point 1 was all about?
Changing the subject slightly last week Gareth Morgan put out his international tax policy. Most proposals were either the existing law – payments must be armslength or won’t get deduction – or government proposals – burden of proof should be on taxpayer. But his key point of difference is he wants all treaties ‘wound back’. I am not there yet but good on him for putting it on the table.
And given the public anger on all of this and OECD not reporting until 2020 when it was one of the original primary issues with the BEPS project – I would watch this space!
All this discussion on Facebook is only possible because until 2014 they had to file accounts with Companies Office. This changed in 2015 to large companies only. Because compliance costs. They still have to file accounts with IRD but rest of us don’t get to see them and their related party transactions anymore.
Let’s talk about tax.
Or more particularly let’s talk about Apple and their taxes.
Your correspondent is currently in Sydney – family stuff nothing glamorous or exciting – and had started to put together a post on Donald Trump and his 2005 tax return. Coz the Sydney Morning Herald had actually explained some stuff behind it and there were some issues that I thought – dear readers – you would find interesting.
But Saturday morning I opened my Herald app to find the latest on multinationals and tax. Apple this time. And yeah that is me. Apparently they have paid no tax in New Zealand. Whether that is 100% true only the Department would know but from looking at the accounts and how it has organised itself – looks pretty damn likely.
So let’s go!
Apple appears to sell products to New Zealand through a New Zealand incorporated company called Apple Sales New Zealand. Note no Ltd at the end. It is owned by an Australian company Apple Pty Ltd.
Now normally a New Zealand incorporated company means New Zealand has full taxing rights on all its income. No need to consider whether income has a NZ source or not . If it has earned income it is taxable. Well that is unless a tax treaty would take away some of those rights. And how could that happen dear readers? Yes that’s right – if it is managed or has directors control in another country.
And is Apple Sales New Zealand (not limited) controlled offshore? Yup the directors are Australian. Ok so then not a New Zealand company for tax purposes.
Now all the income comes from New Zealand so it should be taxed here – right? Well yeah if it has a New Zealand source. And remember that trading in v trading with thing again. Now once upon a time if you wanted to sell almost a billion dollars worth of consumer products you would kinda need to be here. But now http://www.apple.com/nz/ does the business. So thanks to the internet trading in can morph into trading with meaning bye bye income tax base.
Limits of diverted profits tax
Oh but the new things announced by Hon Judith should fix it? You know the diverted profits tax – NZ style? Well not really. The NZ diverted profits tax has some use if there really is stuff happening in New Zealand but clever things have happened to make it look like there isn’t. But here there isn’t stuff happening in NZ. Just people buying stuff from a website.
And remember how all the things a diverted profits tax would help with? Remember how trading with v trading in wasn’t one of them? Yeah this won’t save us.
But the pretending to be a New Zealand company when it is an Australian company. That is a bit cute isn’t it and doesn’t tax avoidance stop cute stuff. Yes it does so what are the facts?
- New Zealand incorporated company
- Australian directors with Australian control
- US website
- Shipping from Australia
- GST registered
- No presence or activity in New Zealand
So taking away any clever stuff. What is actually happening?
An Australian company is selling products to New Zealand via the internet shipping from a warehouse in Australia. What is the tax consequence of this? No tax – as Apple is only trading with New Zealanders not trading in New Zealand.
Compare to current outcome – no tax. Soz nothing for tax avoidance to bite on.
Could it be fixed?
Of course it is possible Apple will get shamed into paying tax here. Putting in New Zealand directors would do the trick. Not holding my breath though. There are also plans by the Government to strengthen our source rules – but nothing proposed tho that will bite on this issue.
What would need to happen is an extension of the ‘contracts made in New Zealand’ rule to say it is deemed to be made in the country of the purchaser for online sales.
So technically not hard.
But here’s the thing. If we do that for Apple – other countries might then do it to Fonterra; Zespri; Fisher and Paykel; Fletcher Building; and Rank when they trade without a footprint. And in this case Apple NZ seems to be paying some tax in Australia. So that will be an interesting discussion with the Australian Treasury.
And it won’t just be the nasty multinationals that get caught. Your correspondent has an extensive vintage reproduction wardrobe. All purchased online from the US and UK from relatively small companies. Risk is such suppliers would see NZ as not worth the effort and stop selling to us. But then now I live in active wear not such an issue for me.
Oh and the not limited thing? It will be a US check the box company as will the Australian Pty company meaning it is an entity hybrid and Apple Inc can choose how to treat it for tax. Cool – but don’t think it impacts on us. Phew.
Thanks to a comment below – I missed a point I really shouldn’t have.
Even if we do change our source rules every treaty we have requires there to be a permanent establishment or fixed place of business before business income can be taxed. So if our source rules were expanded to make income prima facie taxable in NZ the treaty would then allocate taxing rights to Australia.
So short of resinding our treaties – or shaming Apple into paying tax here – we have to suck it up.
There is also the issue of whether it is right to expect tax given Apple isn’t using anything that taxes have paid for. But currently that seems like an argument from another time given the public outrage.
So while taxes are inherently unilateral – this is something that has to be sorted multilaterally. Except I am not aware of any real work on it. And on that I would love to be proved wrong!
Let’s talk about tax.
Or more particularly let’s talk about the release of the recent government discussion documents on taxing the nasty multinationals.
You correspondent had spent the week before last on stage two of her yoga teacher training. No inner child this time but lots of describing poses in anatomical language. ‘The spine is flexed at the pelvis’ aka you bent over. Same lovely people though. Unfortunately my time on the course was punctuated by a day trip to Sydney – yes day trip – for a family funeral. I did however spend both legs watching a documentary on Oasis. So not entirely wasted. Also brought home number 2 son for a week’s visit.
So after all that I was seriously contemplating giving this week a pass too from posting. Coz like: ‘I am enough; I have enough; I do enough’ and other such lessons from the training. I was even looking for a cartoon to stand in its place:
Or possibly – as it is in colour:
But then Friday morning when I was working thru the details for a big family dinner for number 2 son and girlfriend – on comes the lovely Hon Judith Collins announcing the release of the discussion documents on taxing multinationals. Right. Ok. Mmm perhaps the cartoons won’t really cut it for Monday. But channelling my inner bureaucrat – where March counts as ‘early next year’ – Tuesday can count as Monday. Well broadly.
And the proposals are pretty good. Proper thin cap rules for finance companies are still missing but then a seven year time bar for transfer pricing! Whoa tiger. Even at my most revenue protective I’d never have thought of that. Lots of quite detailed techy stuff all which looks pretty effective to your correspondent.
On interest I am also pretty happy. No earning stripping rules but putting a cap on the interest rate should remove the structural flaw discussed previously and levelling the field by removing non- debt liabilities alg.
There is of course the small matter that with the House rising in July(?) and a Budget in May – there is no hope in hell it will even make a bill before this government finishes. Still no sign of any decisions on the Hybrids stuff that was released in September. And that is just as hard.
But if there is change in government this work will give Grant, Mike, James and Deborah an early taste of implementing fairness in the tax system. Coz there is nothing large well advised companies enjoy more than tax base protection. And they hardly ever lobby Ministers; harangue officials; brief journalists or turn up to select committees to advise them of the damage such tax measures will do to the New Zealand economy. So quite a good warm up for their fairness working group.
But I digress.
There are many and varied ways for non-residents to not pay tax with many and varied solutions. Most of which are in the discussion documents. But the one potential solution that gets all the airtime is the diverted profits tax. Which is a pretty narrow solution to a pretty narrow problem. But hey much like the iPhone 7 – irony intentional – even if our tax environment is different or our iPhone 5 is still fine – the UK and Australia have one so we want one too.
What is being proposed is the diverted profits tax equivalent of the iPhone SE – a 6 in a 5’s body. But when your existing phone really isn’t that bad.
And because it all gets so much media attention – this is the one techy thing I’ll take you through dear readers. But I am very sorry there is a bit of background to go through first. Kia Kaha. You can do it.
All taxpayers – resident and non – resident – are taxed on income with a New Zealand source. Our source rules however were devised in 1910 or so. Long before the internet and possibly even before the typewriter. Tbh tho they aren’t that bad and periodically get a wee tweak. They are broadly comparable to other countries. They include all income from a business in New Zealand which can include foreign income as well as income from contracts completed here.
Case law however has narrowed this to income from trading in New Zealand rather than trading with New Zealand. So foreign importers selling stuff to punters here are out of scope but a business here – even an internet business – game on.
The source rules are further narrowed by any double tax agreements. Here now New Zealand business income of a non-resident is only taxable in New Zealand if it is earned by a permanent establishment aka PE. And a PE is a fixed permanentish place of business. Once upon a time it would have been pretty hard to be a real business and not to have a fixed place of business. Possibly not so much now.
So if the non-resident earns business income through a fixed place in New Zealand – taxable – otherwise not. And for historic reasons the fixed place can’t include a warehouse. Coz that is like only preparatory or auxiliary to earning the income – not like the main deal. Yeah I don’t get it either.
Tax planning Apple and Google style
So when you put together the combo of no tax when:
- contracts not entered into in New Zealand;
- income earned from trading with New Zealand;
- no fixed place of business; and
- warehouse doesn’t count.
You kinda get the most widely known of the BEPS issues. The Google and Apple thing. Tbf I think they also use treaty shopping and inflated royalties but above is also in the mix.
Diverted Profits tax UK Style
Now a diverted profits tax doesn’t deal with the ‘trading with’ thing coz that is pretty entrenched and there are limits to anyone’s powers on that. And of course this would mean our exporters who ‘trade with’ other countries would become taxable there too. But it has a go with the other bits.
In the UK their diverted profits tax pretty much deals with situations as above where there is trading in a country and a permanent establishment should arise but doesn’t. The way it works is to say : ‘oh you know the income that would have been taxable if you hadn’t done stuff to not make it taxable – well now it is taxable.’ ‘Oh and it is like taxable at a much higher rate than normal – coz like we don’t like you doing that.’
And now New Zealand
Now in New Zealand that kind of I know you have followed the letter of the law – but dude – seriously is countered by the tax avoidance provisions. And much to the chagrin of the Foreign banks; specialist doctors; and Australian owned companies it does actually work in New Zealand.
And just because the tax avoidance provisions are being successfully applied doesn’t mean that the law shoudn’t be changed. It is a bucket load of work to investigate; dispute and then prosecute successfully. And if there are lots of cases – and there do appear to be – law changes are ultimately less resource intensive.
But even given all that I am somewhat surprised that what they have proposed is very similar to the handwavy tests of the UK. A bunch of clear questions of the structure and then asks if ‘the arrangement defeats the purpose of the DTA’s PE tests.’ Ok. Not a million miles from the parliamentary contemplation test with tax avoidance. So not entirely sure what extra protection it gives us other than being a bright shiny tax thing.
But then how different was the iPhone 6 from the iPhone 5 after all? And while the iPhone 7 is newer and flasher is it actually better?
Who knows though maybe New Zealand’s version of a diverted profits tax has a signalling benefit to the Courts. And its not like it will do any harm. So long as you don’t count additional complexity as harmful.
So all in all not bad. With the earlier Hybrids and NRWT on interest – even if the diverted profits tax equivalent may not add much – all the rest of the proposals should deal to undertaxation of non- residents.