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 email@example.com 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.
Let’s talk about tax.
Or more particularly let’s talk about non-residents buying property in New Zealand.
Your correspondent has never understood the expression the devil is in the detail. Coz as someone who has spent her career in detail – I have always found the truth or the clarity to be in the detail. Because surely it is only from the detail that the high level stuff can come? Otherwise how do you trust that the principles or concepts are right?
All of this came back to me – as I mentioned last week – when a reader asked about the non- resident stats on property purchases. And how they kinda get touted as being both evidence and not evidence of low levels of foreign ownership in New Zealand.
As it all just very confused with claim and counterclaim – it is worth starting at the beginning. And in the beginning was Budget 2015. The government wanted a demand side measure or measures to help cool the housing market aka something to reduce the number or value of buyers in the market. And yeah that is me in the early stuff.
Where they landed was a combination of the:
So the people who have to provide NZ IRD numbers are all companies, trusts and partnerships as well as individuals who have limited connections to New Zealand or are not selling a main home. So pretty much everyone except anyone who can vote and is selling their family home. This meant IRD could track buying and selling of property better and stand a better chance of enforcing the Brightline test as well as the intention test.
And the people who had to supply foreign IRD numbers were anyone – individual or entity – who a foreign country had claimed under their tax residence rules. And it was tax residence before any treaty would apply too so these people could also be tax resident in New Zealand. Think Mr Thiel. This meant IRD could let foreign tax authorities know what their tax residents were doing here . And if the foreign country had a capital gains tax – very likely – they might be interested in this information.
Now let’s have a look at the LINZ pie chart. This chart is simply a summary of those who gave foreign IRD numbers and those who didn’t. So what can it tell us about the level of ‘foreigners’ buying residential property? Well actually absolutely nothing. Coz in the 3% this could include:
- A New Zealand incorporated company with New Zealand shareholders but with directors control in either Australia, China, Canada or the UK. Coz remember from last week how shareholding was irrelevant for residence?;
- A company incorporated offshore with New Zealand shareholders but with high level control in New Zealand;
- An American citizen who lives here all the time buying an investment property;
- A trust with any of the above as a trustee.
Now in practice some scenarios are more likely than not. But the key point is that even tho 3% is small it could also include buyers – as above – that don’t exactly feel foreign.
And in the 60% green – NZ tax resident only – the reverse becomes even more pronounced. This group can include a:
- company incorporated in New Zealand with high level control in New Zealand but offshore shareholders;
- trust with a New Zealand resident company or individual as a trustee but offshore settlor and beneficiaries aka our friends the foreign trusts;
- foreign citizen on a working or student visa in New Zealand for more than 6 months.
And all of this makes complete sense when the objective is helping treaty partners enforce their tax laws. As where there is no tax claim on the individual or entity by a foreign country there is no need for a foreign IRD number. But to consider this group ‘not foreign’ – bit of a stretch really.
Now the really interesting thing tho in all this stuff is there is a defintion in the mix that is a reasonable approximation of ‘foreign’. That is the term ‘offshore person’ (pg 15). It is used for the NZ IRD number requirement and as a carve out from the main home exclusion.
In offshore person there are no tax concepts and comes pretty close to what intuitively would be considered a ‘foreigner’ or a NZ citizen with limited ties to New Zealand. For individuals an offshore person includes non-citizens; citizens who haven’t been here in 3 years or permanent residents who have been absent for a year. For companies, partnerships and trusts it is where the 25% of the beneficial ownership is by these individuals who have these limited ties to New Zealand. Peter Thiel may be an offshore person given how little he seems to be here.
So if you actually wanted a proper foreign register of buyers of residental property or wanted to assess the level of foreign ownership in NZ – that offshore person definition really isn’t bad. It would need work if you started banning these sales as it does include actual NZ citizens and the company/trust foreign threshold is a 25% ownership which is kinda low. But still a lot better than anything based on tax residence.
So is that question asked anywhere? Nah. Facepalm. I guess coz like they really really don’t want a foreign buyer register.
But if you think it through – all the Budget 2015 things were really actually only about tax. And with LINZ being the easiest place to collect the data. So it makes complete sense that this stuff is administered by LINZ – joined up government and all that.
But what doesn’t make sense is why poor old LINZ has to produce these reports. Because honestly why does anyone care what percentage of land sales might be exchanged with a foreign tax authority? Even your correspondent the international tax geek – as the Americans would say – could care less.
But though much like the:
- Bright Line test which is the infrastructure for a capital gains tax;
The offshore person’s test could be the basis of a register of foreign buyers. Thereby continuing this government’s kind provision of the springboard for the next lefty government’s policies. And who says John Key doesn’t have a legacy?
But first LINZ would have to start collecting that information.
PS This is the last post for the next two weeks. I have part 2 of my yoga teacher training coming up. Namaste.
Let’s talk about tax.
Or more particularly let’s talk about tax residence for companies and trusts.
Following Mr Thiel’s post a reader asked about the non- resident purchaser stats that LINZ produces. And so I wrote a post on that. I really did. But as I was going through it it became clear to me that the LINZ stuff was actually super hard. Even for you dear readers. And – given I hadn’t taken yet taken you through the joys of tax residence for companies – super hard was actually super impossible.
So dear readers today you get company residence. And hang in there coz next week you get a discussion of the LINZ data where I try to clear the smoke and mirrors that is those stats. But that is next week. So back to tax residence and companies.
Ok now companies have separate legal personalities and so they can contract and do stuff independent of its shareholders. And the total wheeze is that if the company fails shareholders are not liable for its debts if their capital is fully paid. They do lose the dosh they put in as capital and of course if that was spent on deductible expenses and it is a closely held company those losses can be offset against other taxable income. But you know that already so you won’t get any more on that from me today.
So back to residence. As a company is its ‘own person’ the concepts of prescence or connections with New Zealand used for actual people make no sense with them. They need their own bespoke tests. And in New Zealand they are:
- Head Office
- Directors control
- High level management
If anyone of those is in New Zealand then game on – New Zealand resident – taxable on worldwide income. Or at least before a treaty comes in.
But looking at that list and thinking about how often in tax policy the statement ‘a company is a vehicle for its shareholders’ is used. What is not on that list?
Well done – shareholding. A company could have 100% foreign shareholders – hit one or all of those tests and still be prima facie taxable on its worldwide income in New Zealand. The opposite also applies. A company could have 100% New Zealand shareholders and meet none of those tests. It then would be non-resident and so not taxable on its worldwide income. Now because that is just too cute there are other – controlled foreign company – rules that then come in. But they are for another day.
So key message – residence does not equal shareholding or beneficial ownership. Now in practice there will be significant overlap coz NZ companies are really for NZ resident shareholders. But won’t be a complete set.
And joy of joys other countries have similar tests:
Australia – incorporation or directors control
Canada – Incorporation or directors control
US – incorporation
And yes dear readers – you’ve got it – two countries could claim a company. A NZ incorporated company with effective management offshore in UK or China or Australia or Canada could be claimed by those countries too. Similarly an Australian incorporated company with NZ high level management will get claimed by both Australia and New Zealand.
And then – as with Mr Thiel – the treaty will decide who gets the rose. With companies the test in the treaty is usually the place where the high level decisions aka place of effective management is. So as with Mr Thiel there is domestic law tax residence and residence for the purpose of a treaty. And the music finally stops with the treaty.
Ok well done. Now that wasn’t too hard. Now let’s try trusts. In a trust is a settlor that puts in stuff; a trustee that legally owns the stuff and manages it on behalf of the beneficiaries.
For those of you who followed the foreign trusts thing you may have heard something like ‘ NZ has a settlor based system for taxing trusts’. Now that is almost right. New Zealand has a settlor based system for the taxation of distributions. The residence of the trustee, however, is the starting point for the taxation of trusts.
And the tax residence of the trustee is the tax residence of the company or individual that is the trustee. So again the residence of the trustee could be completely different from the residence of the settlor or the residence of the beneficiaries.
Now why I am labouring this potential disconnect will make more sense next week. Feel free to pre read the LINZ reports in the first link.
Let’s talk about tax.
Or more particularly let’s talk about tax residence.
There is currently is a big to do about Peter Thiel both here and in the foreign press about exactly how did a US billionaire become a New Zealand citizen. Soz can’t help with that. But on my Facebook feed this morning is coming the question – so is this guy tax resident? Now that I can do off the public stuff and is pretty much probs yeah/nah. But citizenship – scmitzerzenship – really not relevant much at all.
There are many concepts of residence used in the bureaucracy. The main one is permanent residence – an immigration concept – which pretty much gives the recipient the rights of a citizen except maybe you can’t stand for Parliament.
Tax residence however – who would have thought – is a completely different concept. While in practice most New Zealand permanent residents and citizens will be tax residents. It is by no means a dead cert.
Now why tax residence matters is that residents are taxed on any foreign income earned and fully taxed on New Zealand income. Tax non-residents are not taxed on foreign income and have concessionary rules on how New Zealand income is taxed. Think Google.
For an individual there are two ways – you can become tax resident and a number of ways you effectively lose it.
The two ways are:
- Being here – an individual who is physically in New Zealand for 6 months in ANY 12 month period becomes New Zealand tax resident.
- Connections to New Zealand – even if you are here less than 6 months in any twelve month period if you have a house you live or have lived in while you are here AND you have other connections you will become subject to tax in New Zealand on your foreign income.
So looking at Mr Thiel. According to reports the dude has two houses in New Zealand. Combined with his New Zealand citizenship and the stuff wot he did to demonstrate commitment to NZ – not free from doubt but – I would say there was a pretty high chance he would hit the connections to New Zealand test. And yes tax friends I am talking about a permanent place of abode but there are non tax people who read this and we’d all agree as terms go it is not the most intuitive.
Now you might be thinking dear readers – woohoo – New Zealand can tax his foreign income. Hello mega surplus and Scandinavian levels of public services.
Ah but not so fast there is now the small matter of the US/NZ tax treaty.
On the basis that he is a ‘naturalised American’ he is also tax resident of the US and they will also claim taxing rights on his foreign income. And here the treaty will sort that out:
- First question is which is the country where he has a home available to him? Ah probs both. Next question.
- Second question which country is where his personal and economic ties are stronger? Mmm tough. A late forties ‘naturalised American’ with business interests there and a confidante of the President v really likes NZ and invests in tech companies. Tricky but I think we can call it for the US.
Now is this tax dodging or tax avoidance? Should we feel aggrieved as New Zealanders that he is a citizen but unlikely to be a tax resident?
I defo don’t think this is tax dodging or tax avoidance as there is nothing cute or clever or structured in being taxed where your stuff is and where your links are stronger. Given the NZ diaspora who are NZ citizens – not all of them will be residents under the two tests and even if they are they will also have the benefit of their treaty. And in theory anyway he should be paying tax on his foreign income in the US.
But I can only hope that when the ‘exceptional circumstances’ were being weighed in Mr Thiel’s application the Minister knew that while we were getting a citizen – given how international tax works – it was unlikely we were getting a taxpayer.
Lets’s talk about tax (and interest deductions for non- residents).
Over the last couple of months, your correspondent has become completely obsessed with the Netflix series The Crown. There really is something for everyone: fifties fashion; power plays and constitutional crises. On top of that it should also be a training video on how NOT to give advice. Some of the incomplete partial advice the young QEII received from her chief advisors – as well as close family – was nothing short of incompetent and unprofessional.
From time to time the Duchess of Windsor makes a minor appearance usually as a plot device for the Duke to explain things too. As well as coming from central casting as chief villian in the abdication saga – even though it wasn’t actually her that abdicated cherchez la femme I guess – she is also famous for that equally feminist quote that a woman can’t be too rich or too thin. I will have to take her word for that having never got that close to either.
Now the thin part turns up in tax in something delightfully known as thin capitalisation. Now while it sounds – and is – quite techy it is a concept that underpins our ability to get tax from non-residents. So you know like quite important then. And also the basis of all my moaning that for all the talk on the government getting tough on multinationals a big ticket item like interest deductions keeps sliding away. And and no one is calling them on it.
Taxation of New Zealand debt
Soz dear readers but before we get to the truly exciting tax thin thing – kinda need to talk about how debt is taxed. But you can do it dear readers – you can do it. Breathe in and out.
When a totally New Zealand business borrows from a totally New Zealand bank – say the local dairy from Kiwibank – the interest paid reduces the dairy’s profit which in turn reduces the dairy’s tax to pay. However Kiwibank has to pay tax on that income.
And the tax is according to the normal rules – the progressive tax scale if an individual or the company or trust rate. So if a business was earning $500 profit before interest of $100 – it now pays tax on $400 but the lender also pays tax on the $100 so $500 is still taxed. So in a closed system – interest causes a repackaging of how tax is paid rather than being a net reduction. [Yes there is lender’s deductions but I am assuming that away ATM as this is hard enough already.]
Taxation of foreign debt
Now this is not the case when the lender is non-resident. Payments are still deductible but the non-resident lender is only taxed at most at 10% non-resident withholding tax. So in the previous example the $500 taxable profit has effectively become $400 taxable profit.
The thing tho is that normal commercial and business considerations will naturally put a lid on how much debt a business has. As you actually have to pay it back and you have to have the cashflow to meet the interest payments. For the economists reading – a graph to keep you interested.
But this isn’t the case though when you are a New Zealand subsidiary being directly funded by a foreign parent. It is going to have to fund you anyway and its balance sheet is taking the risk of your failure. So faced with the choice of funding by debt which costs 10% tax – at most – or 28% the company tax rate if funded with equity … Mmm tricky – let me get back to you in that one.
So as a way of attempting to reapply some commercial pressure on a foreign controlled New Zealand company – the tax rules say if your debt is more than 60% then you are thinly capitalised and interest deductions effectively start to be denied.
And what could be more fair than that?
All – directly or indirectly – foreign controlled companies are restricted to interest deductions on a debt to assets ratio of 60%. Actually two things:
1) Nature of business Some firms through the nature of their business aren’t naturally funded by debt – and so costs other than interest are their major deductions.
Take for example a supermarket that rents its premises. It’s major asset will be its inventory that will primarily be funded by the terms given by its creditors. Its major deductions will be purchases, staff costs and electricity. This means that such a foreign owned business has the ability to insert additional debt and strip out profits based on its asset base that capital intensive businesses that are naturally funded by debt cannot. This is because for them the 60% threshold is already used up to pay for actual assets.
And capital intensive businesses naturally funded with debt can’t just add additional purchases; staff costs and electricity to level the playing field as those costs won’t get profit back to its shareholders.
In practice it isn’t supermarkets as I think they are all New Zealand owned cooperatives. But it is Life Insurers which are naturally funded by their policyholder base and distributors which are also naturally funded by their creditors.
2) Finance companies One of the other parts of the thin cap rules is that any firm that lends to third parties – finance companies – get a reduction in their debt amount and their assets amount by the value of their third party lending. It was originally brought in as a way of not making the rules too onerous for foreign owned banks. As it is completely legit that banks don’t carry equity levels of 40%.
Unfortunately as the tax base found in the Banking tax avoidance cases it really didn’t put any practical constraint on excessive interest deductions.
Now registered banks have their own special banking thin cap rules. But foreign owned finance companies – nothing. Effectively unconstrained interest deductions as was the case previously with the banks.
And then there is a final hole in the rules that might be fair to everyone in the thin cap rules but not so much to anyone not controlled by a foreigner.
Now you have all done really well to get this far. Go and get and drink of water or a cup of coffee and come back. You need to know this next bit.
The thing about the thin cap rules is that they constrain the quantity of debt. Transfer pricing however sets a price for the interest on the debt. And the higher the levels of debt the higher the market price for the interest – as high levels of debt mean there is a higher risk of bankruptcy. This is what the economists graph says above – so it must be true.
But but dear readers I hear you say – the thin cap rules constrain the amount of debt a company can hold so alg. The interest rate can only be at most that which relates to a 60% threshold.
Now well done for getting this far. Unfortunately – close but no cigar. The sequencing – as the economists would say – is:
1) Interest rate is worked out under transfer pricing based on actual amount of debt. Say 20% instead of 7% if really high bankruptcy risk.
2) Interest rate x amount of debt calculated to give potential interest deduction.
3) Potential interest deduction reduced by proportion of debt over 60%.
So as you see the higher interest rate still gets embedded as a deduction. It isn’t like transfer pricing insists on the interest rate that applies to the 60%. It seeks an armslength price for actual debt levels. And that is embedded in our treaties so no way around that.
Now the OECD has proposed an option that would cut right through this. They are proposing that countries adopt an earnings stripping rule which would link the amount of allowed interest to the profit before tax. To the accountants – base the restriction on the P&L rather than the balance sheet.
And yeah that would work. There are a bunch of issues that freak people out like what if I had a bad year and my sales fall and you restrict my interest deduction and I have to pay tax and I have had a bad year and it’s not fair. For these type of reasons there may be reasonable resistance to moving to the OECD proposals.
But our current rules are far from even handed and contain a structural flaw. So Hon Judith if you choose not to adopt the OECD proposals – I look forward to your improvements to the existing rules coz a level playing field they ain’t. And with potentially a wall of American interest deductions looking for a new home, we need to make sure we are protected.
Let’s talk about tax.
Or more particularly let’s talk about the Republican party’s recent proposal to impose ‘border adjustments’ as a reform of their corporate tax system.
To date this has passed me by. Slowly though things have percolated up to various feeds I follow. All talking about how Trump can balance the budget and punish companies that export jobs. The first I saw looked like a GST where imports are taxed and exports aren’t. Fair enough I thought if the US wants to impose import duties – ok but nothing to do with me. I do income tax not tariffs. I won’t be commenting. Good luck with the WTO on that. And our US tax treaty only covers federal income taxes not value added taxes so no issue there.
Then I saw something that said it was income tax. Sales to foreigners wouldn’t be taxed and purchases from foreigners wouldn’t get deductions. And no interest deductions coz it was a cashflow tax. Whoa I thought – that’s odd. How do you deny interest deductions as they are a cashflow? And what about restricting deductions for local purchase costs when you aren’t taxing foreign income? How’s that going to work?
But in that article Professor Alan Auerbach is talking positively about the proposals. Penny dropped.
A few years ago Prof A came to New Zealand with some other academics and gave two presentations on destination taxation that I am embarrassed to say did not understand one word of. Awesome so that is what this is about and I will have to do some actual work to comment rather than accessing my increasingly failing tax memory.
Having now done some work – that is I found the good professor’s 2010 paper and read it – I can see why I didn’t understand. It is a major change in how income tax systems work and so nothing really would have resonated.
Now let’s see if I can paraphrase the 29 pages.
Focus is on taxing cashflows that originate in the US – so:
- Foreign sales not taxed;
- Foreign purchases not deductible;
- All domestic purchases – including capital items – are deductible;
- All domestic borrowings – full amount borrowed not typo keep breathing – are taxable;
- All domestic lending is deductible; and
- Foreign borrowing and foreign lending – not respectively deductible or taxable.
Wow just wow. So wish I had followed this when Prof A came out. I would have had soooo many questions.
The advantages of this are said to be:
- Tidies up the US treatment of foreign income and removes the incentive to move US income to havens because the US would tax it even less. Yep agreed.
- Treats debt and equity equally and removes the tax preference for debt. Yep does that too as while capital items are fully deductible the full amount that is borrowed – so long as it is borrowed domestically – is taxed.
Issues with this though kinda are:
- Not only originally US income could find its way back from abroad. So could most actual foreign income actually earned overseas – as Auerbach is proposing the US become the MacDaddy of tax havens.
- No deductions for foreign purchases but deductions for the same domestic purchase. Mmm what does that sound like? Ah discrimination according to the US/NZ treaty – is what it sounds like. Article 23(4) to be precise.
- Foreign purchases not deductible but domestic sales taxable. Mmm how long will it be before foreign subs start servicing the US market? Now that can be stopped if they reform their controlled foreign company (CFC ) rules – but a CFC is by definition foreign – and isn’t foreign stuff out. It can also be stopped through a reform of the permanent establishment rules as proposed by the OECD but isn’t that a nasty pinko Obama thing?
- Domestic borrowings fully taxable but foreign borrowings not. Too easy. Bye bye local banks. Hello City of London.
There are other things like I am not at all sure that full deductibility for long lived assets is at all the right policy as it doesn’t match the decline in their economic life. So the longer lived the asset the greater the tax expenditure – because why? Is there a shortage of long lived assets in the US economy? And accelerated depreciation was the basis for the double dip leases that were all the rage around and before 2000. But maybe the requirement that the asset has to be in the US will protect them this time.
Now that was 2010 and an academic paper. Let’s see what has actually proposed by policy makers – Paul Ryan nonetheless.
Paul Ryan’s 2016 tax policy allows: full deductions for capital expenditure; repatriation of foreign dividends tax free; ‘border adjustment’ aka taxing imports and exempting exports; ‘streamlining’ subpart F aka CFC rules and denying deductibility for net interest. So pretty much Professor Auerbach’s proposal with a corporate tax cut to 20c and not the foreign bank preference.
As a big interest whinger – here, here and here – I am going to be really interested to see how interest denials stay the course. The rest of the proposal looks pretty standard right wing with a bit of foreign bashing with the foreign purchase deduction denial. But denying interest – wow – that is huge. Further than I would go even with a reduced corporate tax rate. But then maybe the interest deductions will flow into foreign countries at the same time the income is flowing out. All the more reason for New Zealand to a make sure we have interest deductions for non- residents properly sorted. Next week’s post promise.
In Paul Ryan’s thing there are some spurious references to the WTO and how they are mean to the US – I think that is called doing their job – but no reference to the tax treaty breaches. But the IRS international tax counsel know all about these issues and I hope they are being funded properly – coz buckle up boys – their competent authorities are about to get really busy. Oh and it’s Article 23(3) in the US treaty with China.
And the servicing of the US from say Canada and Mexico – don’t know how far drones can fly – pretty sure though it’s higher than the average wall or fence. But that is my bet as to what will happen when imports are denied a tax deduction. Not more tax revenue and not more jobs. And lots of warning for the companies who can start looking at border real estate. Just like the GOP – so very business friendly.
Yep. Making America great again – one own goal at a time.
2016 has been some year.
Donald Trump; Brexit and then the deaths of Leonard Cohen; David Bowie; Prince; George Martin; Helen Kelly; Zsa Zsa Gabor, George Michael as well as the heart attack of Carrie Fisher. But one friend has had a baby and two have got engaged – although not to each other – so not a complete write off.
One death though – that has recently made the international tax community poorer – was that of Tim Edgar a Canadian tax academic.
Tim originally trained as a lawyer – and taught at law schools – but a less lawyery person you could not meet. Cases drove him mental. Once in conversation he suggested that instead of the Courts we should just use a random number generator for tax avoidance. Although to be fair it would also work for any of the objective subjective cases like capital/revenue or residence.
Odd numbers for the Commissioner – even for the taxpayer. Very fair. And would – he argued – have the effect that taxpayers would just stay away from anything that would get them put in the generator in the first place. Good policy outcomes with reduced fiscal cost. What’s not to love?
Tim came to Wellington with his family on sabbatical in early 2000s and worked in Inland Revenue policy. I can’t remember what he was supposed to be working on – GST possibly – but because of his ability and good humour very quickly became a sounding board and contributor to pretty much every team in the division. He also lived close to me and our families had a lot to do with each other over that time. We introduced the Edgar family to the joys of Fish and Chips.
After that period in Wellington, we kept in touch and our paths crossed a number of times including a joint stint presenting an OECD course in India. Again his depth of knowledge and good humour made him very popular with the participants while his North American tipping practices made him popular with the staff at the hotel.
By the mid 2000s I had become completely obsessed by hybrids in the way my children were with pokemon. So I wanted to analyse them and their effects for my masters dissertation. There was a small difficulty in that there was no one in New Zealand with the expertise who could supervise me. So I approached Tim.
With his usual good humour and generosity – although possibly it was the opportunity to earn $100 in NZ foreign exchange that clinched it – he agreed. And within 2 weeks I had a parcel of the key items of the hybrids literature in my mailbox. Not sure that is standard operating practice for most supervisors. But then Tim wasn’t most people.
At the time (2004- 2006) there were two views on hybrids. The first – dude get over it countries can do what they like aka the sovereignty argument and the second – it is double non -taxation/ bad aka the economic distortion argument. I wasn’t fully convinced by either view. Tim, however, was very firmly in the latter camp and – quelle surprise – history has proved him right.
Tim was a high level strategic person – but in the sense that he did actually have big picture insights – rather than just someone who can’t cope with complexity or detail. He was expert in Financial Arrangements; GST; international tax; tax structuring or pretty much anything he decided to have a look at.
I particularly remember him sharing his views on formulary apportionment which is touted by parts of the left as the ‘fair’ way to allocate worldwide tax revenues. The thing is – he said – there is nothing normative about allocating through source and residence. What that has going for it though – is that all the countries agree. Formulary apportionment throws all that up in the air – and who knows where you’ll end up?’
We last caught up around his fiftieth birthday – which I am embarrassed to see is almost 5 years ago. He shared with me the changes in his personal and professional life and how proud he was with how his children were doing. He was more subdued than previously but was looking forward to the next stage of his life.
I don’t think this and similar articles was what he had in mind though – particularly as he was always so fit. I struggled to find a photo that represented how I remember him. Even this one which I swiped from his uni’s obituary doesn’t show the exuberant enthusiasm he had for discussing any one of the topics around his head.
I had him on my list of people to contact now I have left the reservation but sadly this post will have to do instead. I will however always remember the laughter, the low ego/high ability combo and the non-standard approach to thinking about tax.
So go well my dear friend. Hail and farewell.