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?
Let’s talk about tax (havens).
After eight days on a yoga course the role of balance in postures and in life was a recurring theme. And upon finishing the course this was brought home to me quite starkly. As after eight days of sequencing Sun A and B without naming the poses, understanding my inner child and hugging people that were a week ago complete strangers – your correspondent spent the subsequent week talking about multinationals and tax havens.
Yin and yang. Perhaps not as it is traditionally known but defo in my life.
Now my views on multinationals are ‘on the record’ but I realised I haven’t ever properly discussed tax havens.
Putting aside for a moment that no country has ever owned up to being a tax haven. And so much like the term ‘fat’ – it is in the eye of the beholder.
There are a number of criteria floating around but really they can be summarised as:
- low or no tax and
So yeah for New Zealand and foreign trusts pre Shewan report probs more tax haveny than not and post Shewan less tax haveny than not.
In the campaigns against them, tax havens are often swept up with the ‘multinationals – bad’ messaging. And the story goes something like this:
Multinationals strip profits from developing countries to tax havens. No tax paid in developing country or tax haven. Profits then not sent home coz they don’t want to pay tax on them. Double non-taxation – bad thing – everyone loses.
But in that story there are 2 quite distinct players:
- The developing country who is capital importing and
- the home country who is capital exporting.
The concerns of the developing or capital importing country – of which New Zealand is one – is to ensure that some tax is paid for the use of resources or on the location specific rents.
The concerns of the home or capital exporting country is to ensure that it receives some tax – after foreign tax is paid – for the capital invested.
Traditionally these two concerns have been reconciled through the OECD model for tax treaties. Broadly the approach is to let the source or capital importing country tax first but not too much. Then let the residence country also tax the income but give a tax credit for tax paid at the source country level.
Now that all works beautifully when structures are very simple and the person earning the money in the source country belongs to the capital exporting country. It becomes much more complicated when even simple entites like companies are in the mix. And it all starts to completely break down when tax paid in the capital importing country has no value as a tax credit to the ultimate owner of the capital.
Coming back to tax havens. For capital exporting countries where the multinationals are headquartered, tax havens then are a complete bugg@r. They potentially – will come back to this – put a block on the return on capital from the source country to them.
For capital importing countries like NZ the issue is not so clear. As IMHO isn’t the real concern returns leaving the country untaxed rather than where they go? Coz we have already seen with the use of hybrids it is quite possible for tax to be paid nowhere without a tax haven in sight. Also that income could also be directed to companies in the international group that were otherwise loss making – cross border loss refreshment. So really for capital importing countries, tax havens are just a tool in the mix rather than the definitive source of tax badness.
The story with tax havens being a blight on developing nations is also more nuanced than would first appear as they are often tax havens themselves. Vanuatu? Cooks? Admittedly more low rent – and therefore I would imagine more exploitable – than say Jersey or Bermuda but they still turn up on lists of potential havens.
Also capital exporting and importing countries are not as powerless against tax havens as it would first appear.
For capital exporting countries there is a 50 plus year old tool called the controlled foreign company rules that can be used against tax havens. The way it works is to say – you know if any foreign company is ultmately controlled by anyone in our country – well guess what we want to tax that income too. Trick can be knowing that income exists and so that is why the disclosure campaigns, TIEAs and automatic exchange of information are so useful. And if there continues to be non- disclosure this ups the ante with the tax administration to become potentially tax evasion and the spectre of the prison wall.
For capital importing countries its weapon of choice is the even more old school withholding taxes. Payments made to tax havens can have tax withheld at what ever rate you choose if you don’t have a tax treaty with that country. And if the treaty is a problem – it can strictly speaking be withdrawn.
The fact that these don’t happen really – IMHO – comes down to an international consensus to tax capital income more lightly than labour income. Aggravated by:
- The zero rate of tax borne by charities and pension funds;
- The active income exemption from the controlled foreign company rules;
- Classical taxation of dividends.
None of which provide any incentive to pay tax at the source country or even the home country.
Now tax havens can still be annoying to New Zealand to the extent our people have undisclosed money offshore – and the non- complying trust is worthy of its own future post – but as a country we are a net capital importer and so have much the same issues as the developing countries. And at times the label tax haven comes our way too – fairly or not.