Ok. So the story so far.
The international consensus on taxing business income when there is a foreign taxpayer is: physical presence – go nuts; otherwise – back off.
And all this was totally fine when a physical presence was needed to earn business income. After the internet – not so much. And with it went source countries rights to tax such income.
However none of this is say that if there is a physical presence, or investment through a New Zealand resident company, the foreign taxpayer necessarily is showering the crown accounts in gold.
As just because income is subject to tax, does not necessarily mean tax is paid.
And the difference dear readers is tax deductions. Also credits but they can stand down for this post.
Now the entry level tax deduction is interest. Intermediate and advanced include royalties, management fees and depreciation, but they can also stand down for this post.
The total wheeze about interest deductions – cross border – is that the deduction reduces tax at the company rate while the associated interest income is taxed at most at 10%. [And in my day, that didn’t always happen. So tax deduction for the payment and no tax on the income. Wizard.]
Now the Government is not a complete eejit and so in the mid 90’s thin capitalisation rules were brought in. Their gig is to limit the amount of interest deduction with reference to the financial arrangements or deductible debt compared to the assets of the company.
Originally 75% was ok but then Bill English brought that down to 60% at the same time he increased GST while decreasing the top personal rate and the company tax rate. And yes a bunch of other stuff too.
But as always there are details that don’t work out too well. And between Judith and Stuart – most got fixed. Michael Woodhouse also fixed the ‘not paying taxing on interest to foreigners’ wheeze.
There was also the most sublime way of not paying tax but in a way that had the potential for individual countries to smugly think they were ok and it was the counterparty country that was being ripped off. So good.
That is – my personal favourite – hybrids.
Until countries worked out that this meant that cross border investment paid less tax than domestic investment. Mmmm maybe not so good. So the OECD then came up with some eyewatering responses most of which were legislated for here. All quite hard. So I guess they won’t get used so much anymore. Trying not to have an adverse emotional reaction to that.
Now all of this stuff applies to foreign investment rather than multinationals per se. It most certainly affects investment from Australia to New Zealand which may be simply binational rather than multinational.
Diverted profits tax
As nature abhors a vacuum while this was being worked through at the OECD, the UK came up with its own innovation – the diverted profits tax. And at the time it galvanised the Left in a way that perplexed me. Now I see it was more of a rallying cry borne of frustration. But current Andrea is always so much smarter than past Andrea.
At the time I would often ask its advocates what that thought it was. The response I tended to get was a version of:
Inland Revenue can look at a multinational operating here and if they haven’t paid enough tax, they can work out how much income has been diverted away from New Zealand and impose the tax on that.
Ok – past Andrea would say – what you have described is a version of the general anti avoidance rule we have already – but that isn’t. What it actually is is a form of specific anti avoidance rule targetted at situations where companies are doing clever things to avoid having a physical taxable presence. [Or in the UK’s case profits to a tax haven. But dude seriously that is what CFC rules are for]
It is a pretty hard core anti avoidance rule as it imposes a tax – outside the scope of the tax treaties – far in excess of normal taxation.
And this ‘outside the scope of the tax treaties’ thing should not be underplayed. It is saying that the deals struck with other countries on taxing exactly this sort of income can be walked around. And while it is currently having a go at the US tech companies, this type of technology can easily become pointed at small vulnerable countries. All why trying for an new international consensus – and quickly – is so important.
In the end I decided explaining is losing and that I should just treat the campaign for a diverted profits tax as merely an expression of the tax fairness concern. Which in turn puts pressure on the OECD countries to do something more real.
Aka I got over myself.
In NZ we got a DPT lite. A specific anti avoidance rule inside the income tax system. I am still not sure why the general anti avoidance rule wouldn’t have picked up the clever stuff. But I am getting over myself.
Of course no form of diverted profits tax is of any use when there is no form of cleverness. It doesn’t work where there is a physical presence or when business income can be earned – totes legit – without a physical presence.
And isn’t this the real issue?
It is seriously odd being out of the country when seminal events occur.
On that Friday I was in London. Waking at 4.30 am and checking Facebook. Just coz.
My Christchurch based SIL posted that she was relieved now she had picked up her kids from school. Sorry what? Thinking there might have been another earthquake I checked the Herald app.
In the swirl of issues has come the suggestion Facebook and Google should be taxed into compliance. Of course a boycott could be equally effective. Except if users of Facebook are anything like your correspondent and there is inelastic demand. Possibly not at insulin levels but until demand changes I am not sure taxation would be that effective.
But the whole issue of tax and Facebook, Google and Apple has been a running sore for many years now and so I thought I’d take a bit of time to go through the background of it all. [Really keen readers though could search Cross border taxation on the panel on the right for more detail]. Future posts will look at what is being proposed as a solution in New Zealand and by the OECD.
Background to the background
The international tax framework since like forever aka League of Nations – before even I was born – has been that the country that the taxpayer lives in or is based in – residence country – can tax all the income of that taxpayer. Home and abroad – all in.
Where it gets tricky is the abroad part. As the foreign country, quite reasonably, will want to tax any income earned in its country – source country.
So the deal cut all those years ago – and is the basis of our double tax treaties – was:
For business income the source country gets first dibs if the income was earned through the foreign taxpayer physically being in their country – office, factory etc. Rights to tax were pretty open ended and the residence country of the taxpayer would give a credit for that tax or it would exempt the income.
So far so good.
Except if there were no physical presence then there was no taxing rights. But in League of Nations times – or even relatively recently like when I first went to work – the ability to earn business income in a country without an office or factory was pretty limited. So as constraints go – it kind of went.
For passive income like interest, dividends, and royalties the source country could tax but the rate of tax was limited. 10-15% was standard. And again the residence country gave a tax credit for that tax or exempted the income.
Looking now at our friends Apple, Google and Facebook. Apple provides consumer goods and Google and Facebook provide advertising services.
When your correspondent started work, foreign consumer goods arrived in a ship, were unloaded into a warehouse and then onsold around the country. Such an operation would have required a New Zealand company complete with a head office, chief executive and a management team. All before you got to getting the goods to shops to sell.
Such an operation would most likely have involved a New Zealand resident company. Even if it didn’t no one would be arguing about a physical presence of a foreign company as – to operate in New Zealand – it would have needed more physical presence than Arnold Schwarzenegger. And yes both creatures of the eighties.
For advertising services, no ships involved but people on the ground hawking classified and other ads for newspapers. Again more physical presence than Princess Di. [Getting to the point – promise – as am now running out of 80’s icons]
Now internet enter stage left.
For goods consumers now don’t need to go to a shop. iPads and iPhones bought on line. Physical presence non existent along with (income) taxing rights.
For services – more interesting. Still seems to be some presence but like – sales support – not like completing contracts. So no taxable presence and no (income) taxing rights.
Phew. So everything is ok now.
Next post. Promise.
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 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.